This article was issued and approved by Square Mile Investment Services Limited which is registered in England and Wales (08743370) and is authorised and regulated by the Financial Conduct Authority.
Quality investing; the approach of investing in businesses with durable fundamentals that allow them to compound value over the long term, has always been a long-term investment journey. As part of that journey, however, there will be inevitable bumps in the road. Because, even when investors own high-quality businesses with strong balance sheets and durable competitive advantages, markets can sometimes favour other names, themes or styles.
Knowing this doesn’t make underperformance any less palatable. In fact, investors who focus on the quality investment style have no doubt had their conviction severely tested of late. The good news, though, is that there is now plenty of evidence strongly pointing to conditions for quality investing improving.
Key takeaways:
- Quality names have struggled recently due to both macro and market forces negatively impacting their share price performance.
- Due to underperformance, valuations have sharply reset, creating attractive entry points for many compelling names.
- Our portfolios maintain allocations to quality-biased managers while remaining diversified across different investment styles, recognising that diversification by manager style is just as important as geographical diversification.
A robust long-term style
Quality investing has historically produced consistent outcomes across full market cycles. Companies with pricing power, disciplined capital allocation and resilient balance sheets tend to protect capital better in downturns and compound more reliably in market expansions. Over time, the high returns on capital and reinvestment can drive superior wealth creation.
Yet, this doesn’t mean there won’t be ups and downs in the short term. Sometimes the types of companies that markets prefer can change over time, in reaction to trends or the macro backdrop. When there is plenty of money in the market and investors feel confident, they often prefer companies that are more sensitive to economic growth or cheaper stocks or riskier ideas. In these phases, companies that grow steadily, which are usually seen as quality names, can appear pedestrian.
This is why having a disciplined investment approach is key to get through periods of underperformance. By focusing on the underlying characteristics that define quality, such as profitability, cash generation and balance-sheet strength, it’s easier to remain committed to the investment philosophy that quality names have the ability to achieve superior wealth creation over the long-term.
Why the latest cycle proved so challenging
Having a disciplined approach has been especially vital over the past year, due to the following macro and market forces at play:
- Higher for longer inflation and interest rates: These supported nominal earnings growth, more cyclical sectors and asset-sensitive companies.
- Market returns became increasingly concentrated: A small group of mega-cap technology stocks captured a disproportionate share of performance, driven by enthusiasm around artificial intelligence.
- Investor behaviour became more driven by recent market trends. For a time, investors preferred companies tied to the economic cycle and those delivering quick earnings growth, rather than businesses that grow steadily over the long term.
These forces meant diversified quality portfolios faced strong headwinds, even though many continued to deliver earnings growth, robust free cash flow and have strong balance sheets. The challenge came from investor preference and subsequent valuation compression, not deteriorating fundamentals.
Valuations after the reset
Many high-quality businesses now trade at valuations implying only modest long-term growth, despite strong track records and durable competitive positions. In many cases, premiums to the wider market have narrowed or disappeared, with expectations embedded in share prices appearing more conservative than during the ultra-low rate era. For long-term stock pickers, this creates a more attractive opportunity set.
From a forward-looking perspective, this matters enormously as starting valuations are a key driver of long-term returns. Buying shares at high prices can limit future performance even when fundamentals remain strong, but if those prices dip in a valuation reset, prospective returns improve as the business quality is unchanged. Periods of volatility and style rotation can therefore create opportunities to strengthen portfolios at attractive entry points. And, after recent relative underperformance, positioning in quality now also appears less crowded. Style leadership often shifts once expectations have moved too far in the opposite direction.
At the same time, the macro environment is evolving in ways that have historically favoured quality. While rates remain higher than in the prior decade, they have at least decreased and inflation pressures have moderated, so the cost of capital has become more stable, reducing a primary headwind for long-duration cash flows.
Moreover, in later stages of the economic cycle, investors often place greater emphasis on balance-sheet strength, margin resilience and sustainable returns on capital. Companies with robust finances and strong cash generation are typically better positioned to continue investing, defend profitability and gain market share if growth slows or volatility increases.
The cost of abandoning discipline
For advisers, the key lesson is as much behavioural as it is analytical so highlights the importance of helping clients maintain a long-term perspective and stay committed to a well-constructed investment approach. Periods when a particular investment style falls out of favour are a normal part of investing. History shows that moving away from a style such as quality after a weaker period can mean locking in underperformance and missing the recovery that often follows.
It’s also vital to remember, at times like these, that quality investing is only temporarily out of favour. The underlying businesses themselves continue to generate cash, reinvest at attractive rates and reinforce their competitive positions. The reset in valuations, combined with a more supportive macro backdrop and realistic expectations, has therefore materially improved the opportunity set.
For us, at the portfolio level, this means maintaining exposure to quality-biased managers while ensuring diversification across managers with different but complementary styles. Just as geographic diversification is a core element of risk management, diversification by manager style can play an equally important role in building resilient portfolios.
Owning great businesses at sensible prices remains one of the most reliable ways to build wealth over time. Indeed, at Titan Square Mile, we have long believed it is quality that endures. So while the recent cycle may have tested conviction, it has not undermined the structural case for quality. If anything, it has refreshed it.
Important Information
This document is marketing material issued and approved by Square Mile Investment Services Limited ("SMIS") which is registered in England and Wales (08743370) and is authorised and regulated by the Financial Conduct Authority. The independent research is provided by Square Mile Investment Consulting and Research Limited ("SMICR") which is not authorised or regulated by the Financial Conduct Authority and does not undertake regulated activities. Titan Square Mile is a trading style of SMIS and SMICR. SMIS and SMICR are wholly owned subsidiaries of Titan Wealth Holdings Limited (Registered Address: 101 Wigmore Street, London, W1U 1QU).
This document is aimed at professional advisers and regulated firms only and should not be passed on to or relied upon by any other persons. It is not intended for retail investors, who should obtain professional or specialist advice before taking, or refraining from, any action on the basis of this document. It is published by, and remains the copyright of, SMIS. SMIS makes no warranties or representations regarding the accuracy or completeness of the information contained herein. This information represents the views and forecasts of SMIS at the date of issue but may be subject to change without reference or notification to you. This document does not constitute investment advice, a recommendation regarding investments or financial advice in any way and shall not constitute a regulated activity for the purposes of the Financial Services and Markets Act 2000. Should you undertake any investment activity based on information contained herein, you do so entirely at your own risk and SMIS shall have no liability whatsoever for any loss, damage, costs or expenses incurred or suffered by you as a result. SMIS does not accept any responsibility for errors, inaccuracies, omissions, or any inconsistencies herein. Past performance is not an indication of future performance.
Date: April 2026
