Although the long-term evidence supporting quality investing is compelling, no investment approach outperforms in every environment. Periods of underperformance are natural when pursuing a highly disciplined investment approach, and quality is no exception.
The roots of quality’s recent underperformance can be traced back to around 2021. After a prolonged period in which higher-quality businesses had generally performed well, valuations had become stretched in places. As those valuations gradually normalised, some of the prior outperformance from quality also began to unwind.
This adjustment also occurred while investor attention was becoming increasingly concentrated on a narrow group of large US technology companies, leaving much of the rest of the market – including US smaller companies – relatively overlooked. Importantly, JUSC’s emphasis on valuation helped mitigate much of this pressure.
More recently, sentiment has played a decisive role. In 2025, as equities rebounded following April’s ‘Liberation Day’ sell-off, leadership gravitated towards higher-risk areas of the market. This closely resembled the ‘risk on’ behaviour seen in other market rallies such as those in 2003 and 2009, when markets were initially led by more speculative stocks with higher leverage, greater operational sensitivity and weaker underlying fundamentals.
Evidence from the US small cap market illustrates this clearly. The chart below shows that stocks exhibiting higher volatility and market sensitivity performed strongly, while the characteristics we favour – such as low leverage and high earnings quality – lagged.
Inevitably, this represented a challenging environment for quality investors. When sentiment favours risk-taking, investors may prioritise cyclical upside or balance sheet leverage over earnings durability or business model resilience.
However, history suggests that these phases do not last indefinitely. Previous cycles demonstrate that while lower-quality companies may lead the initial recovery, leadership typically broadens over time as investors refocus on the fundamental characteristics that drive long-term returns. That dynamic provides useful context when considering what may lie ahead for quality investors.
