High Quality: A 'North Star' Through The Market Cycle

Summary

• In this environment, we favor a focus on investing in companies we believe to be high-quality companies.
• This approach emphasizes stability and resilience, aiming to insulate assets from unpredictable swings in the market while positioning for sustainable long-term growth.
• While equity markets have been resilient, multiple economic and geopolitical pressures are contributing uncertainty as to where we go from here.

By Daniel Hanson, CFA

An emphasis on quality can drive outperformance through market cycles.

With markets hitting all-time highs across the world, investors are asking some basic questions: Where are we in the market cycle? Should I reduce risk? Or should I remain exposed to the enthusiasm over artificial intelligence that has driven recent gains?

In this environment, we favor a focus on investing in companies we believe to be high-quality companies. This approach emphasizes stability and resilience, aiming to insulate assets from unpredictable swings in the market while positioning for sustainable long-term growth. Among its key tenets:

1. High quality: In our view, quality companies, characterized by low debt, consistent earnings growth and robust profitability, offer a dual advantage: They have the potential to keep pace with the market during rallies, providing investors with growth opportunities. More importantly, we believe they could provide some insulation on the downside, should the market correct. As they say, defense wins championships.
2. Absolute risk management: We strongly believe in absolute risk management—i.e., in minimizing risk of permanent capital loss. While comparisons to a benchmark are a convenient way to evaluate performance, risk management should be about “sleep at night” risk, where reducing the probability of losing capital is prioritized.
3. Portfolio construction reflects conviction: As active fundamental investors, we believe in expressing our conviction through position sizes. In our view, a bar-belled portfolio across the growth-value spectrum of high-quality “compounders” is a sensible way to navigate a market cycle, with the growth component helping keep pace with the market, and less “glamorous” companies (including asset-rich, sound and stable franchises) providing a cushion when growth is out of favor.
4. Valuation matters: We believe in owning great businesses at fair prices as defined by future earnings. We also welcome market dislocations and volatility (e.g., the 2022 Fed tightening) as they provide opportunities to own quality at discounted prices. In our opinion, the price one pays for a business directly affects whether it will succeed as an investment.
5. Ownership mindset: By definition, an investor with an ownership mindset will look under the hood to understand the competitive moat of potential investments. By digging deeper than financial metrics, one can uncover key advantages enjoyed by the company.

While equity markets have been resilient, multiple economic and geopolitical pressures are contributing uncertainty as to where we go from here. Armed with the elements above, we believe it’s possible to find opportunities across the market cycle, providing a “North Star” when a cloudy outlook otherwise makes navigation difficult.

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