January 2026 Quality’s role amid equity market uncertainty
Global equity markets delivered another year of strong returns in 2025, but higher quality companies lagged the returns of the overall market. With 2026 now upon us, heightened geopolitical tensions, trade uncertainties, and potential AI-driven valuation risks support the case to revisit the key defensive characteristics of the Quality factor.
For 2025, world equity markets delivered another year of double-digit gains, underpinned by positive momentum, stocks with lower valuations, and small-cap stocks (particularly those outside of the US). High growth stocks and those offering higher yields also recorded healthy returns, albeit returns that modestly underperformed the broader market. Despite achieving solid absolute returns, companies with lower risk and higher quality characteristics lagged the rest of the market. The relative underperformance is illustrated in Figure 1, which shows the total returns across common factor indices in developed markets for 2025.
Historically, Quality offers a return premium over broad indices, driven by behavioral mispricing and compounding benefits. Investors often underappreciate the durability of high-quality fundamentals, leading to undervaluation relative to their true prospects and leading to long-term outperformance.
Behavioral biases play a key role. In especially buoyant market environments, higher quality companies can underperform as they are left behind in the fervour for higher risk and more speculative investments. However, in periods of weaker markets this very conservatism can be a benefit—historically, higher quality companies have been significant outperformers in these conditions.
This interaction between Quality and market environment is not a pure risk play, as demonstrated by the performance of Quality in “normal” market environments. Low or minimum volatility indices, for example, typically outperform broad market indices in weak periods, and lag in markets characterized by strongly bullish sentiment. However, in the more normal environments, these single dimension low risk approaches have also underperformed on average, as depicted in Figure 3. Quality shows a meaningful return advantage compared to cap-weighted indices, even in these periods.1
We incorporate our own, nuanced and multi-faceted definition of Quality as one of the four key themes within the Systematic Equity Alpha model. The model forecasts stock returns across our full investable universe and powers the Systematic Equity Active, Enhanced, and Defensive suite of strategies. Within our Quality theme, we incorporate signals that target elements of asset quality and capital efficiency as well as building targeted tangible and intangible quality metrics sector-by-sector. While there may be periods, such as 2025, when Quality was not a strong driver of relative returns, we remain confident in the diversification benefits it brings to our overall model and therefore potential returns for our strategies.
Quality is key to navigating market fragility
As we progress through 2026, several threats could challenge equity markets and further reinforce the case for Quality exposure. For example, geopolitical tensions have the potential to disrupt global supply chains and investor confidence. Furthermore, continuing uncertainty around trade also poses risks, particularly given the volatility experienced during prior tariff escalations. Meanwhile, the exceptional gains achieved by companies in AI-related fields have contributed to greater market concentration, which in turn heightens vulnerability to sentiment reversals. Given elevated AI and private market valuations, there is the risk of sharp corrections if growth fails to materialize, especially in the most concentrated pockets of markets. In addition, macroeconomic fragility, characterized by slowing global growth and diverging monetary policies, could amplify volatility across regions.
While Quality underperformed in 2025, its defensive attributes and consistent fundamentals position it as a valuable diversifier amid rising risks. With uncertainty likely to remain a feature of the year ahead, Quality may play a critical role in navigating potential market fragility.
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