High-quality firms historically outperform – even in crises

MSCI research indicates U.S., global, and emerging-market stocks with exposure to the quality factor are resilient outperformers

High-quality firms historically outperform – even in crises

The start of 2022 sent a shiver down the spine of the stock market. Global equities, particularly those companies going through blistering growth, ultimately cooled two years into the pandemic rally, as increasing inflation, imminent interest-rate rises, and the war in Ukraine frightened equity investors.

However, high-quality firms have weathered the storm rather well. Anil Rao, Executive Director at Equity Solutions Research, recently examined the evidence as to why these businesses have stood strong against the wave of crisis that hit the market.

In a blog post, Rao observed that in both growth and value segments of the market, high-quality enterprises have historically performed excellently. This was true in the United States, the rest of the world, and emerging markets.

Using the MSCI FaCS definition, which encompasses multiple facets of a company’s quality reflected in financial statements, he brings to light the significance of one of the lesser-known characteristics of high-quality companies: their ability to withstand market and industry shocks.

“This has relevance for today’s backdrop of geopolitical risk and surging inflation,” Rao noted.

Rao examined the track records of quality organizations across the three major equity markets — the U.S., non-U.S., and emerging markets (EM) — and within each of these, divided them into value and growth sectors, as well as high- and low-quality halves. His analysis focused on gross returns in U.S. dollars from December 1996 to February 2022.

The results were clear: during the last two decades, higher-quality stocks overwhelmingly outdid their lower-quality counterparts. They also had lower realized volatility, which was essential. This outperformance was seen across the value-growth spectrum as well as our three market regions.

He pointed out that higher-quality enterprises were especially resilient during instances of market stress, such as the 1998 Russian sovereign collapse, the September 11 attacks, and the 2003 Iraq war, which are all relevant to present conditions.

“Throughout the more recent period of our study, from late 2021 through today, high-quality growth stocks outpaced their low-quality counterparts by a wide margin in the U.S. and EM,” Rao said.

He also found that beginning in late 2021 until February 2022, higher-quality growth beat lower-quality growth significantly.

“One reason for these results, over both long periods and short-term difficult ones, could be the durable business models and sustained competitive advantages of quality firms,” he suggested.

Examining the composition of the MSCI ACWI Index from December 1996 until February 2012, he found that 75% per cent of the companies that started out as high-quality stayed that way, perhaps because of their vast economic moats or fortress balance sheets. In contrast, only a third of lower-quality enterprises were able to cross the chasm to higher quality after a decade.