There are many ways to define quality companies. GMO’s focus in quality investing for 40+ years has been on companies that have a consistent and enduring ability to deliver high returns on their investments. This requires a business with continued growth and relevance, tight control to replicate assets, and strict capital discipline on management’s part. These companies often identify themselves by delivering a track record of high profitability, stable profitability, and a strong balance sheet.
A Track Record of Strong Risk-Adjusted Return
As of 9/30/2023
* Inception Date: 2/6/2004
† Average return for all down months
‡ Average return for all up months
Why GMO Quality?
- Valuation matters. While we believe quality companies are worth a premium, an attention to valuation provides a margin of safety against the risk of overpaying for unrealistic or unsustainable growth expectations. And our valuation focus ensures that we are buying stocks with muted – not over-hyped – market expectations.
- When it comes to growth, we look forward – not back. Our attention to valuation does not mean we can’t participate in the upside – high ROI growth is worth a big premium! GMO’s Quality Strategy has outperformed the S&P 500 and MSCI World in a variety of environments over the last 1-, 3-, and 5-year periods ending September 30, 2023. A quality valuation approach can find great opportunities – even during growth periods like the one we’re in today.
Why invest now?
- Finance theory tells us that achieving higher returns requires taking more risk. But in equity markets, higher quality stocks have outperformed lower quality stocks by a considerable margin despite being much less risky.
- The GMO Quality Strategy presents investors with an ideal core equity holding that has delivered strong returns, stability, and downside protection for nearly 20 years and counting. Even so, in today’s environment we believe there are a few notable reasons that make investing in quality particularly worthwhile:
- High rates are bad for asset prices, but in our view the impact of a changing discount rate on growth stocks seems overstated. We expect our results to primarily be driven by the ability of our quality companies to allocate capital successfully over time. 1
- Similarly, we note that quality stocks have tended to fare well compared to the broader markets in times of rising prices, and that paying attention to valuation alongside quality delivered even better results. We believe the fundamental characteristics of the GMO Quality Strategy’s holdings further underpin the ability of our investments to withstand inflationary episodes. 2
- During bear markets, cheap high-quality stocks have outperformed on a relative basis. That doesn't mean they don't go down, but rather that they go down much less than the market – the weakest businesses are revealed when times get tough.
- Quality-at-a-reasonable-price investing can benefit from innovation trends like AI and the GLP-1 class of drugs. Even if the most high-profile stocks have stretched valuations, there is often a broad ecosystem providing many investment opportunities and high-quality incumbents get their share (or more) of the profits.
- Given quality tends to trail in up markets, it’s easy to see why some may hesitate to allocate to quality when focused on relative performance. But as our research and the GMO Quality Strategy’s track record show, quality keeps up well enough on the upside and more than compensates on the downside to compound over the cycle and outperform over time.
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See Growth Investing Ain't About the Rates (October 2022).
See Quality Investing and Inflation (June 2021).