They think it’s all over… for quality growth

5 minute read

Autumn Budget 2025

It’s no secret that it has been a tough few years for quality growth managers such as Lindsell Train and Fundsmith, and 2025 was particularly miserable. As we entered 2026, the hope was that things were so bad, and recent underperformance versus core and value strategies was so stark, that things were bound to get better.

Then, on Tuesday, LSEG, RELX, and several other European data companies were down double digits on news that Anthropic, the company behind AI chatbot Claude, unveiled a new AI legal tool that competes with existing legal software. This sort of share price volatility doesn’t scream ‘quality’, so what’s going on, and is this a buying opportunity or time to draw stumps on quality growth as an investment style?

Quality is in the eye of the beholder

Investors often say they buy good companies but depending on who you ask you’ll get different answers as to what really constitutes ‘quality’. Typically, it includes characteristics like:

high return on invested capital
stable and growing earnings
low financial leverage
strong and defensible competitive advantages

The thing is, it is rarely a secret when a business possesses these characteristics, so these companies may be quite expensive. The key question for investors often revolves less around whether the company is a good one, but whether its stability and future earning potential is already fully reflected in the share price. A great company can still be a bad investment if the price is wrong.

The bet most quality managers are making is that the market underestimates the persistence of these companies’ dominance and don’t extrapolate their earnings far enough into the future. This investment strategy is often called “beat the fade” (in earnings expectations).

When should quality growth do well?

Whenever you assess a manager or investment style, you need a strong sense of the environments they should perform well (and badly) in. Without this, you can’t assess whether they are doing a good job. We need to know whether strong performance has just been lucky, or whether weak performance is explainable. These are just a few scenarios where you might expect quality growth to come up trumps:

In an economic downturn. At times like these investors value predictability, stability, and stocks which are less sensitive to the economic cycle so their earnings can still grow.
When markets fall. Often this coincides with an economic downturn, but not always. Again, when risk appetite sours, stability is the order of the day.
When interest rates (and inflation) are low. This means the present-day value of future earnings aren’t heavily discounted, so long term secular growers can command very high valuations, as they did in the 2010s.
When the past is a good guide to the future. Quality businesses have a history of strong earnings delivery, so if the future looks a lot like the past, then why wouldn’t this continue?

None of these scenarios have played out so far this decade. Of course, we had the briefest recession in history when the Covid pandemic first hit, but since then global economic growth has been strong, particularly in nominal terms, due to loose fiscal policy and higher inflation.

Equity markets have been on a tear too, with MSCI ACWI almost doubling in value since the start of 2020. There have been some bumps in the road – the first half of 2022 and Liberation Day in April 2025 come to mind – but quality managers outperformed during these episodes, as you would expect. Meanwhile, interest rates and bond yields have reverted higher too.

So, it is understandable that the investment style has been something of a dog in recent years. If the environment changes, and it will at some point (although maybe we’ve seen the last of zero interest rates for a while) then the stage is set for quality growth to come roaring back. Or is it?

Something something… AI

The fourth scenario I mentioned above is when the past is a good guide to the future. I’m always wary of the overused phrase that the world is “unusually uncertain”. We all tend to look at the past as if it was more predictable than the future. Usually it wasn’t, and we’ve forgotten about all the things we were worried about at the time, but there’s a strong argument to say this time is different.

We are in a period of immense disruption of business models by AI. AI isn’t like the metaverse, a flash in the pan, AI is more like the internet in terms of its potential to change the way the world works.

This means that quality growth companies, and indeed any company at all, can be affected positively or negatively. Businesses that just a few years ago had almost unassailable competitive positions can now come under pressure overnight, as we saw on Tuesday.

Quality companies don’t usually face existential threats, but what happens if the fade in earnings becomes a cliff? You can argue that these threats are overblown or just plain wrong, but perhaps it’s understandable that investors are shooting first and asking questions later. It took years, even decades, before the impact of the internet was fully felt, so may be some time before there’s enough widespread belief that these quality companies will be fine and valuations can revert to where they were before.

The game has changed

All investors now have the added spice of a somewhat binary bet as to whether a company they buy will be an AI winner or loser. The consequence of being a loser could be terminal.

There are physical industries that should be well insulated, such as miners. But more knowledge-based ones, like software companies or professional services companies, may not be so secure. This sort of downside risk isn’t something you normally expect in a high quality company, so it’s important to be aware that while quality is still desirable, and a strong balance sheet remains hugely valuable to weather a cyclical downturn, the longevity of industry dominance and the path of future earnings have in many cases become more of a punt.

These punts may prove to be correct, only time will tell, but these are higher risk bets than quality growth managers were making before, so investors must go in with their eyes open.

CJ Cowan

Portfolio Manager

CJ is a portfolio manager of the Quilter Investors Cirilium and Monthly Income Portfolios. CJ joined Quilter Investors in August 2018 from Aberdeen Standard Investments where he worked in the global macro team, managing global government bond and global aggregate portfolios.

CJ is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. CJ has a degree in economics from the University of Bristol and an MPHil in Economic and Social History from Brasenose College, University of Oxford.