The dispersion in returns between momentum and quality strategies over the past year has been enough to test the very best investors. According to Justin Onuekwusi, CIO at St. James’s Place (SJP), over the past 12 months momentum strategies have outperformed their quality peers to the region of some 45%.
While this has led index-tracking funds to outperform strongly, given their tendency to do well in more concentrated and momentum-driven markets, it has led to frustration for active investors for whom relying on market timing is not part of their investment strategy.
However, as Onuekwusi notes, every equity style has periods where it appears superior, just as every style goes through stretches where it seems more fundamentally challenged. Indeed, given the dispersion between momentum and other styles has been so extreme, SJP has recently started to lean, albeit slightly, back towards quality in its approach.
In this portfolio constructor head to head, Tom Kynge, multi-asset manager at Sarasin & Partners, argues that while quality companies are beginning to look more attractive, it remains a very exciting time to be a thematic growth investor. Meanwhile, Liam Nunn, head of value equity research at Schroders, gives the value fund manager’s perspective on how to navigate the challenge.
Tom Kynge, multi-asset portfolio manager, Sarasin & Partners
It was a difficult year for quality growth investors in 2025, as low-quality, high-beta companies tended to outperform quality compounders. In part, this was due to heightened retail investor participation, which drove many pre-profit and lower-quality firms to re-rate on valuation – even as fundamentals remained flat or deteriorated.
This year has been somewhat better for growth, supported by the extraordinary profits being accumulated by AI-linked companies. Profit per share growth is expected to reach 30% or higher this year. The equity markets’ reliance on the AI infrastructure trade is central to this profit growth, with the tech sector alone accounting for more than two-thirds of overall market profit growth this year. Add data centre-related industrials and miners, and the concentration grows further.
This is concerning, as it highlights the market’s reliance on a single theme, but it is also a generational moment to be a growth investor. Today, the AI trade is focused on the picks and shovels – semiconductors, data centres and power. With Anthropic recently announcing a 14-fold increase in sales over one year, there is more to play for.
Where the market will be focused a year from now is another question: what intelligence-linked bottlenecks will AI help to resolve, and who will benefit from this increase in economic value? This is where we are spending most of our time.
Quality has continued to lag behind, however, as fiscal deficits and significant AI spending have underpinned strong nominal economic growth. When economic cyclicality drives markets higher, quality tends to lag while many lower-quality companies outperform.
After a period of poor performance, valuations of quality companies have started to look more attractive. This is particularly true in parts of the market most exposed to AI disintermediation, such as platform software. Adobe is a useful example – its PE valuation has fallen from 35x in 2023 to 10x today, even as expectations for sales and profits have continued to rise.
It seems like an interesting opportunity, until you consider that Adobe’s main source of revenue comes from creative professionals using photo or video editing software – something AI is increasingly proficient at.
The question then becomes: what does the Adobe business look like in 10 or 20 years? How many creatives will be displaced by increasingly efficient AI software, and how many new AI-native competitors may emerge?
We cannot answer these questions today. As a result, Adobe’s terminal value is in question, regardless of how cheap the shares may look.
Thematic growth and quality are the two pillars behind identifying attractive investment opportunities today. Structural thematic growth points to the right sectors and industries for the current moment. Quality then narrows the field to the right companies within those industries, with the aim of protecting client capital and outperforming over the long term.
Today, that means capital is being deployed in what some might regard as lower-quality industries where the thematic case for investment is strong. Banks and miners are two good examples, which are supported by financial deregulation and resource security, respectively. While these are not the highest-quality industries, we maintain a bias toward the highest-quality companies within them.
Putting that all together, quality growth as a style has been out of favour since late 2024, but valuations of quality companies have become more attractive. Economic momentum remains strong, providing a modest headwind to the quality factor – but on the other side of the ledger, this is one of the most exciting times to be a thematic investor that we have seen since at least the 1990s.
Liam Nunn, value fund manager and head of value equity research, Schroders
We are value investors that look for a margin of safety by buying assets at a deep discount to their intrinsic value. For many years, that meant most of the capital-light, quality-growth darlings of the 2010s sat far outside our wheelhouse. Today, several have made it into the portfolio, and that shift says as much about value investing’s adaptability as it does about those stocks.
Over the past decade, value funds have often been typecast as a bet on banks, energy and other cyclical, asset-heavy sectors. But genuine value investing is really about avoiding overheated areas – where stocks are ‘priced for perfection’ – and identifying pockets where sentiment has turned so negative that share prices have fallen to irrational lows.
The persistent patterns of human behaviour that drive stockmarkets mean these pockets of ‘fear’ and ‘greed’ are always shifting, and the areas that interest value investors shift with them.
Five years ago, with interest rates anchored near zero and oil prices collapsing during the Covid lockdowns, banks and energy companies sat firmly in that fear zone, trading at deeply discounted multiples of through-cycle earnings. Select opportunities remain there today, but those sectors are no longer as indiscriminately cheap as they once were. Fresh opportunities are emerging elsewhere instead, often in more asset-light industries that were, until recently, the preserve of quality growth investors.
Many global consumer staples companies – a sector long heralded as the preeminent home of ‘quality compounders’ – have de-rated to the point where the market seems to be pricing in a quite a pessimistic view of their long-term earnings power. For instance, leading alcoholic beverage producers – from brewers to spirits manufacturers – are facing structural fears around shifting consumer preferences, including the growing popularity of weight-loss drugs.
In many cases, however, even after stress-testing our numbers for those structural risks, the valuations on offer look attractive. This is the distinction that matters most to us: a lowly rated share is not the same as a mispriced one, and we are interested in the latter. The same can be said for a number of other consumer staples businesses – from leading European cosmetic franchises to Japanese soft drink bottlers and niche Korean snack producers. A sector that could once do no wrong is suddenly very much out of favour with many market participants.
It is important to stress, however, that done properly, value investing is not blind contrarianism. Falling share prices do not automatically equate to value. Only when we were wholly satisfied that valuations chimed with our process did we buy into businesses in these areas. Stocks can trade on low multiples for good reason, so avoiding value traps is central to how we operate.
Our analytical framework aims to help us weed out as many value traps as possible, and we maintain a watchlist of more than 1,000 businesses in our archive, enabling us to act decisively when companies that were not previously cheap enough fall into genuine value territory.
Market darlings and unloved stocks have a habit of swapping places over time. Our aim is to stay alert to those shifts and exploit the resulting opportunities.
This article originally appeared in the September issue of Portfolio Adviser magazine
