What Happened to Quality Investing in 2025

For most of the past two decades, "buy quality and hold forever" sat at the top of the conventional wisdom pyramid for individual investors. Funds that built portfolios around businesses with high returns on capital, durable competitive moats, low debt, and predictable earnings were celebrated — Terry Smith's Fundsmith Equity in the UK, Nick Train's Lindsell Train funds, Chuck Akre's Akre Focus, and the broad family of MSCI Quality and Morningstar Quality factor indexes. They delivered double-digit annualised returns through the 2010s and rebuilt much of investors' faith in active stock-picking.

Then 2025 happened. Fundsmith Equity — the £16 billion behemoth that had long been Britain's most popular fund — returned just 0.8% in sterling terms against a 12.8% gain for the MSCI World Index. Lindsell Train UK Equity actually fell 7.2% in a year when the FTSE All-Share rose roughly 24%. The MSCI World Quality Index trailed the broader MSCI World by 4.66 percentage points for the calendar year, and over the eighteen months from mid-June 2024 had lagged by roughly 11% — a deviation never seen in the previous twenty years of factor data. For a generation of investors who treated quality as the closest thing to a free lunch the market offered, the year posed an uncomfortable question: is the strategy broken, or just bruised?

This primer surveys what quality investing actually is, which funds were hit hardest in 2025, why the factor lagged, what history suggests happens next, and how investors who currently hold these funds might think about the decision to stay put or rotate elsewhere.

What "Quality" Means in Investing

Quality is one of the canonical equity factors identified by academic finance, alongside value, size, momentum, and low volatility. Whereas value asks "how cheap is the stock?" and momentum asks "how strong is the recent trend?", quality asks a different question: "how good is the underlying business?"

The most influential commercial definition comes from MSCI. The MSCI Quality Indexes screen for companies based on three fundamental variables:

• High return on equity (ROE) — a measure of how efficiently a company turns shareholder capital into profit
• Stable year-over-year earnings growth — a measure of business predictability and resilience
• Low financial leverage — measured as the debt-to-equity ratio

Each company in the parent universe receives a Z-score on the three metrics; the quality index then selects the top-scoring constituents and weights them by market capitalisation multiplied by their quality score. AQR Capital, Morningstar, S&P Dow Jones, and FTSE Russell each maintain their own slightly different versions, but the spirit is the same: tilt the portfolio toward profitable, stable, conservatively financed businesses.

Active quality managers like Terry Smith and Nick Train apply additional qualitative overlays. Smith's three-step process is famously simple: "buy good companies, don't overpay, do nothing." A "good company" in his framework typically has gross margins above 60%, returns on capital above 25%, low capital intensity, and a long runway of incremental reinvestment. Train layers in a brand-and-franchise lens, favouring consumer staples, financial data businesses, and media owners with intangible assets that compound for decades.

Conceptually, quality is meant to act as a defensive factor. The historical record shows quality stocks experienced lower maximum drawdowns than the broader market in more than two-thirds of calendar years over the last twenty years, and the factor has tended to outperform during economic contractions when investors fly to certainty. That defensive reputation is exactly what made 2025's underperformance so jarring.

The 2025 Reckoning by the Numbers

Quality posted the worst performance among major equity factors on a global basis in 2025. The headline magnitudes:

• The MSCI World Quality Index returned 16.94%, while the parent MSCI World Index returned 21.60% — a 4.66 percentage point gap
• Quality indexes trailed their parent benchmarks by 6.4% in the US and 5.5% in World ex-US, according to MSCI's own factor commentary
• The S&P 500 Momentum Index returned 26.86%, the S&P 500 Growth Index returned 22.18%, and the broad market returned roughly 17.88% — quality sat at the bottom of that ranking
• Since mid-June 2024 through the end of 2025, the MSCI World Quality Index underperformed the MSCI World by approximately 11% — a magnitude unprecedented in twenty years of data

The pain was uneven across the active management universe. Some quality-tilted funds matched or even modestly beat their benchmarks; others lagged by double digits. The funds that lagged most severely shared three characteristics: they were highly concentrated, they had little or no exposure to Nvidia and the broader AI capex cycle, and they had heavy weights in consumer staples or asset-light intangible-driven businesses that derated as long-term yields rose.

Quality Funds That Lagged in 2025

The table below collects the most-discussed quality funds and their reported 2025 calendar year (or trailing twelve-month) returns. Note that benchmarks differ — Fundsmith and Lindsell Train Global benchmark against MSCI World in sterling, Akre against the S&P 500 in dollars — so the gap to benchmark, not the absolute return, is the more comparable figure.

A closer look at three of the highest-profile cases:

Fundsmith Equity

Terry Smith's flagship has now underperformed the MSCI World for five consecutive calendar years. Yet over the full life of the fund — from inception on 1 November 2010 through the end of 2025 — it has still produced a cumulative gain of 612.9% versus 467.6% for the index. In his 2025 annual letter, Smith attributed the year's shortfall to three specific factors: index concentration (the ten largest stocks accounting for 39% of the S&P 500 and 50% of its returns, the most concentrated reading since 1930), the gravitational pull of passive flows that mechanically push capital into the largest constituents, and a weaker US dollar that reduced the sterling value of his predominantly dollar-earning holdings. Fundsmith owns three of the Magnificent Seven (Alphabet, Meta, Microsoft) but does not own Nvidia, which alone accounts for roughly 7% of the S&P 500.

Lindsell Train UK Equity

Nick Train's UK fund had an even more painful year, falling 7.2% versus a 24% gain for the FTSE All-Share. The fund's 108-month top-quartile streak ended definitively, and 2025 marked the fifth consecutive year of underperformance. The drivers were structural rather than idiosyncratic: zero exposure to banks (which rallied on a steeper yield curve), zero exposure to oil majors and miners (which surged on rising commodity prices), and heavy weights in consumer staples like Diageo, Unilever, and Heineken Holding, all of which derated meaningfully. Outflows have been brutal — Lindsell Train's group AUM has fallen from £24.3 billion in July 2021 to roughly £11.4 billion by late 2025, with £2.6 billion of withdrawals in 2024 alone.

Akre Focus

The Akre Focus ETF returned just 1.23% for the trailing twelve months ending 31 December 2025, versus 17.88% for the S&P 500 Total Return. Chuck Akre's successors describe 2025 as "a tale of two halves" — strong absolute and relative gains in the first half gave way to severe drawdowns in the back half as software-oriented holdings derated on AI-disruption fears. The Mag 7 dominated, rising nearly 25% in aggregate and accounting for more than half of the S&P 500's three-year return, while Akre's concentrated portfolio of capital-light compounders sat largely outside that trade.

Other notable laggards

• Polen Capital Focus Growth — the quality-focused approach lagged the broader index as high-beta names regained leadership and Polen's holdings derated through the AI sentiment shift
• Stewart Investors Asia Pacific Leaders — chronic underperformance led parent First Sentier to transition the strategy to its FSSA team in November 2025
• Lindsell Train Global Equity — the GBP class returned roughly -1.1% YTD; the EUR class -6.0%; both well behind the MSCI World

The contrast with the iShares MSCI USA Quality Factor ETF (QUAL), which returned 21.46% for the trailing year, is instructive. QUAL's index methodology happens to include large weights in Apple, Microsoft, Nvidia, and Alphabet — companies that score well on ROE, earnings stability, and leverage despite their AI-driven valuations. Pure mechanical quality screens that defaulted to the largest profitable mega-caps did fine in 2025; high-conviction, off-benchmark quality portfolios did not.

Why Quality Lagged: Five Drivers

1. Index concentration and the AI capex cycle

The most-cited culprit. The Magnificent Seven (Apple, Nvidia, Microsoft, Amazon, Tesla, Alphabet, Meta) ended 2025 at roughly 33-35% of the S&P 500's market capitalisation and contributed approximately 42% of the index's total return. Alphabet returned around 66% for the year, Nvidia roughly 39%, and the cohort delivered returns in the high-20s versus high-teens for the broader index. Active quality funds with conviction-weighted portfolios that excluded or underweighted Nvidia (which most quality managers viewed as too capital-intensive or too richly valued for its hardware-cycle exposure) were starting from a structural deficit. Smith halved Fundsmith's positions in Microsoft and Meta during 2025 over concerns about a £600 billion combined annual capex spend by the four largest hyperscalers, an underweight that compounded the gap as those names continued to rally.

2. Profitability factor weakness inside quality

MSCI's factor decomposition shows that the profitability sub-factor — the income-statement-driven part of quality — was the primary drag, while balance-sheet-oriented signals (low leverage, strong interest coverage) actually held up. The mechanism: in risk-on, AI-driven rallies, investors reward speculative, unprofitable high-beta names. Profit margins of mature compounders did not expand in 2025; meanwhile, the market re-rated companies with weak current profitability but credible AI-enabled future growth. Quality, defined as current profit per unit of capital, was structurally on the wrong side of that re-rating.

3. Valuation reset after a 2023-2024 melt-up

The Morningstar US Quality Factor Index gained 77% cumulatively in 2023-2024 as AI enthusiasm pulled mega-cap tech higher. By the start of 2025, names like Nvidia and Apple were trading at rich multiples even by quality standards. When sentiment briefly turned in early 2025, the quality index disproportionately swung from "risk on" to "risk off" — its valuation cushion was thin, and high-priced quality stocks proved more vulnerable than low-priced cyclical value names that had spent the prior two years de-rating.

4. The value rotation: banks, commodities, defence

Sectors with little or no representation in quality portfolios led 2025. Financials rallied on a steeper yield curve and a wave of bank deregulation. Gold and silver hit record highs, lifting miners. Germany broke its fiscal rules to commit to a €500 billion infrastructure fund and lifted constraints on defence spending, which (combined with NATO commitments to higher spending floors) drove European defence stocks up triple digits in some cases. The S&P 500 Pure Value Index outpaced the benchmark by 4.3% in August alone. Quality factor strategies underperformed value by approximately 8 percentage points per annum in 2025 — among the widest gaps on record.

5. Dollar weakness amplified the pain for sterling investors

The DXY dollar index fell roughly 9% in 2025. For UK-domiciled funds like Fundsmith and Lindsell Train Global, which hold predominantly US-listed companies whose revenues are dollar-denominated, the currency translation alone produced a multi-percentage-point headwind that did not affect dollar-domiciled benchmarks.

Is the Quality Factor Broken?

The question is impossible to answer definitively, but the historical record offers important context. Quality has had multiple multi-year drawdowns in its measurable history — most notably during the 1999-2000 dotcom melt-up and the 2020-2021 reflation rally — and in each case the subsequent recovery was strong enough to restore long-term outperformance. From 2011 to early 2026, the MSCI World Quality Index has produced a cumulative return of roughly 617%, well ahead of the MSCI World's 452%, despite the recent slump.

There are two competing narratives about whether 2025 represents a buying opportunity or a regime change.

The bull case rests on three points. First, mean reversion: factor returns historically zigzag, and a one-year drawdown of this magnitude has been followed by strong relative returns 75-80% of the time over the next three years, according to MSCI and Morningstar factor histories. Second, fundamental decoupling: research from Russell Investments and others argues that high-quality companies grew earnings throughout 2025 even as their share prices fell, opening the widest valuation gap between price and intrinsic value in a decade. Third, macro regime: quality has historically outperformed when economic growth slows, when default rates rise, and when monetary policy turns more restrictive — all of which several 2026 outlook pieces from BlackRock, J.P. Morgan, and Schwab consider plausible. Cliff Asness's AQR research on Quality-Minus-Junk has consistently shown quality producing positive risk-adjusted returns over multi-decade samples.

The bear case is more nuanced. AI may genuinely represent a generational shift in productivity that justifies historically high multiples for the firms with the data, distribution, and compute scale to capture it — and traditional quality screens that penalise capital-intensive infrastructure spending may be systematically excluding the next decade's compounders. Capital-light franchises in consumer staples may be facing genuine secular pressure, with private-label growth, weight-loss drugs reshaping consumption, and premium-brand pricing power weakening. The deeper concern is that "quality" as conventionally defined — high ROE, stable earnings, low debt — may be backward-looking, capturing companies whose moats were built in the analogue era. If so, a methodology refresh rather than mean reversion is required.

What History Says About Funds in Drawdown

Persistent underperformance in concentrated active funds historically resolves in one of three ways:

1. Mean reversion to long-term outperformance — Fidelity Magellan under Peter Lynch, Tweedy Browne, and the Sequoia Fund have all gone through 3-5 year underperformance windows before rebounding to extend their long-term outperformance

2. Permanent regime change — Janus Twenty in 2000, several growth-at-any-price funds in 2008, and the original Bill Miller Value Trust streak in 2008 represented genuine breaks where the strategy never recovered prior heights

3. Manager succession or stylistic drift — Stewart Investors' transition to FSSA in November 2025 is a recent example; funds either reinvent themselves or quietly merge

Distinguishing case 1 from case 2 in real time is genuinely hard, which is why most academic studies of fund persistence (Carhart 1997, French and Fama updates) find limited predictive power in recent performance. The relevant question is therefore not "has this fund underperformed?" but "is the underlying philosophy still sound, and is the manager applying it consistently?"

What Should Holders of Quality Funds Do?

This is not investment advice; it is a framework for thinking about the decision.

Reasons to consider holding

• Time horizon matters: a five-year holding period that ends in 2025 looks ugly; a ten- or fifteen-year window that includes 2010-2020 and recovers a normal factor cycle still likely shows quality compounding. Fundsmith's full-life return of 612.9% versus 467.6% for the MSCI World remains intact despite the recent slump.
• The driver of underperformance is identifiable and partly mean-reverting: index concentration at 1930 levels and an 11% factor drawdown are statistical extremes, not stable steady states.
• Quality's defensive properties have not been disproven — they simply did not help in a rip-roaring AI-led bull year. If 2026 brings a slowdown, default cycle, or AI capex disappointment, the same portfolio that lagged in 2025 could lead.
• Switching costs are real: capital gains tax in taxable accounts, bid-ask spreads, and the behavioural risk of buying high (in whatever you rotate into) and selling low (in what you exited) often erode rotational gains.

Reasons to consider trimming or rotating

• The fund's investment process has visibly changed without your conviction following — for example, Smith halving his Microsoft and Meta positions represents a meaningful philosophical shift you may or may not endorse.
• The fund represents an oversized position in your portfolio (more than ~15-20% in any single active strategy is concentration risk regardless of how good the manager is). Recent outflows suggest many investors had let Fundsmith or Lindsell Train grow into overweight positions during the 2010s.
• You can express the quality philosophy more cheaply via a passive ETF — the iShares MSCI World Quality Factor UCITS ETF charges 0.25% per annum, less than a quarter of Fundsmith's all-in cost, and produced a comparable ten-year return.
• Concentration in one style is worth diversifying — pairing a quality fund with value, small-cap, or international exposure reduces single-factor risk and historically improves risk-adjusted returns.

A practical middle path

Many financial planners are recommending a partial rebalance rather than a binary stay-or-go decision. Rebalance the position back to its target weight (selling some if it had grown overweight, holding if it has shrunk), pair the active quality holding with a complementary value or small-cap allocation to reduce style concentration, and re-evaluate in 12-24 months against the manager's stated process — not just against the benchmark. The relevant test is not "did Fundsmith beat the MSCI World last year?" but "did the businesses Fundsmith owns continue to compound earnings and deepen their moats?" If the answer to the latter is yes, the share price gap will close eventually. If the answer is no, that is a more serious signal to act on.

Conclusion

Quality investing did not stop working in 2025; it ran into the most concentrated index in nearly a century, a violent value-led sector rotation, a re-rating of capital-light franchises, and a dollar headwind that compounded the gap for sterling investors. The result was a year in which iconic quality vehicles — Fundsmith, Lindsell Train UK Equity, Akre Focus, Polen Focus Growth — turned in their worst relative performance in a decade or more.

History suggests this is uncomfortable but recoverable. Drawdowns of similar magnitude have historically been buying opportunities rather than exit points, and the same defensive characteristics that hurt quality in a melt-up year are precisely what make it useful when the macro environment turns. But "history" is an average; individual funds within the quality umbrella diverge meaningfully, and the right response depends on whether the philosophy is still being applied consistently, whether the fee level remains justified versus passive alternatives, and whether the position size is appropriate within the broader portfolio.

The investors most likely to regret a 2026 decision are those who chase the trade that worked in 2025 — concentrated mega-cap AI exposure — at the precise moment that trade has become the most consensus-heavy in a generation. The ones most likely to do well are those who diversify across factors, periodically rebalance, and resist the urge to evaluate any single strategy on a one-, two-, or even three-year window. Quality investing has been declared dead before. Each previous obituary turned out to be premature.