23 Oct 2025 4 min read Insights

When Quality Investing Fails

Even great businesses can be poor investments—if you buy them wrong or hold them too long.

For years, quality investing has been considered the most rational, durable approach in public equity markets. The premise is intuitive: invest in businesses with high returns on capital, strong moats, low leverage, and consistent earnings. Hold them for years. Let compounding do the heavy lifting.

This strategy, championed by firms like Fundsmith, Baillie Gifford, Fidelity, Capital Group, and Wellington, has long outperformed—until it didn’t.

Between 2021 and 2023, many high-profile quality-focused investors significantly underperformed the market, despite owning businesses that were fundamentally strong. Why? Because quality alone is not enough—especially when valuation, sentiment, and regime shifts are ignored.

The Scorecard: When Quality Broke Down

Let’s look at the real-world drawdowns experienced by quality-centric managers and funds in recent years:

Fundsmith Equity Fund (Terry Smith)

Strategy: Buy high-quality global growth businesses (consumer, healthcare, tech)
2022: –13.8%, underperforming MSCI World by ~430 bps
Trailing 3-year annualized return (2021–2023): 5.5%, vs. MSCI World at 7.8%
Key holdings like Microsoft, L’Oréal, and Meta declined despite steady fundamentals

Terry Smith, 2023: “The companies we own didn’t fail. The market changed how it values quality.”

Baillie Gifford Long Term Global Growth

Strategy: High-growth compounders with global scale
2022: –51%, with massive drawdowns in Shopify, Zoom, and MercadoLibre
Trailing 3-year return: –17% annualized, vs. MSCI ACWI at 6.2%
Peak-to-trough loss in flagship trusts (e.g. Scottish Mortgage): Over 60%

Baillie Gifford acknowledged they were “early on transformative trends but overpaid for duration,” reflecting a key blind spot: they ignored technical signals and regime context.

Fidelity Blue Chip Growth Fund

Strategy: Buy high-quality large-cap US growth companies
2022: –33.7%, vs. S&P 500 at –18.1%
Underperformance driven by large weightings in Meta, Amazon, Nvidia
Multiple compression in high-ROIC tech names led to deep drawdowns, even with earnings intact

Capital Group’s New Perspective Fund

Strategy: Quality compounders with global diversification
2022: –25.5%, underperforming global benchmarks
3-year return (2021–2023): 4.1%, vs. MSCI ACWI at 6.2%

Capital Group: “We held strong businesses through sharp valuation resets. The challenge wasn’t the companies—it was the market regime.”

This wasn’t a failure of fundamentals. It was a failure of strategy rigidity. Here’s what quality-focused managers consistently missed:

1. Duration Risk in a Rising-Rate World

Quality-growth companies (trading at 30–50x earnings) were disproportionately hit as the discount rate rose.
These were long-duration assets—high future cash flows, low present value under higher rates.

2. Valuation Discipline Eroded

Quality became synonymous with “pay any price.” Stocks like Adobe, ASML, and Intuitive Surgical traded at 60–70x FCF during peak sentiment.
When expectations reset, the businesses were still great—but returns collapsed.

3. Crowded Trades and Herding

Everyone owned the same 15–20 names: Visa, Microsoft, LVMH, Thermo Fisher, Adobe.
This created fragility—once one stock cracked, it dragged others via factor exposure.

4. No Attention to Technicals or Macro Regime

Fund managers dismissed price action as noise. But as sentiment shifted, prices led fundamentals.
Downtrends persisted even when earnings didn’t collapse—technical breakdowns drove further outflows.

Who Outperformed? Quality + Technicals + Valuation

While traditional quality investors underperformed, a handful of investors who blended fundamentals with tactical awareness outperformed—or protected capital more effectively.

Mark Minervini (US-focused growth)

Combines earnings quality, strong ROIC, and technical strength
Avoids stocks breaking down on volume, even if fundamentals are intact
2020–2023: Significantly outperformed benchmarks by using tight risk control and trend confirmation

“The market doesn’t pay you for being right on the business. It pays you when the stock confirms the move.” — Minervini

William O’Neil-Inspired Funds (CAN SLIM Method)

Blend of growth fundamentals + price strength + timing
Avoid entering positions in downtrends, no matter how high the business quality
2022: Preserved capital while quality-growth peers experienced 30–50% drawdowns

Some Hedge Funds with Factor-Tilt + Technical Models

Firms like Point72, Schonfeld, and QVT used quant overlays to dynamically manage exposure
When quality factor underperformed, they reduced position sizes or rotated exposure

The Key Insight: Fundamentals Must Be Contextualized

Owning a great business is necessary—but not sufficient. If you:

Buy at euphoric valuations,
Ignore price action,
Dismiss macro context (like liquidity, inflation, or rates),

...you risk suffering multi-year underperformance, even with "bulletproof" companies.

Evolving the Quality Playbook

Here’s how to modernize the traditional quality strategy:

1. Overlay Technical Confirmation

Wait for uptrends or breakouts before building full positions
Respect 200-day moving averages, volume trends, and price leadership

2. Define Valuation Boundaries

Use IRR-based valuation, reverse DCF, and peer benchmarking
Don’t chase quality at 50x just because “it’s a great company”

3. Monitor Macro Regimes

In rising-rate or inflationary environments, shift exposure to shorter-duration quality (e.g., cyclicals with cash flow today)
Use macro signals (e.g., credit spreads, yield curves) as overlays

Final Thought: Quality Is the Starting Point, Not the Whole Map

Owning durable, capital-efficient businesses is still the foundation of great investing. But as recent years have shown, quality alone can’t protect you from sentiment shifts, valuation extremes, or macro headwinds.

The edge now comes from integrating the timeless with the tactical—combining deep business analysis with market awareness.

The best investors in the next cycle will still own quality. But they’ll buy it with discipline, size it with risk awareness, and time it with technical confirmation.