A quality investing strategy has some of the same benefits of a well-made pair of sneakers, said Ranjit Sufi, managing director and head of institutional services for Aristotle Capital Management, during a fireside chat at the Canadian Investment Review’s 2023 Defined Benefit Investment Forum in December.
For Sufi, the importance of quality dates back to his teenage years. When a certain pair of athletic shoes were popular with his classmates, his parents purchased a similar shoe from a knock-off brand at a lower price point. “Two weeks later, the shoe was in shambles.”
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Quality investing is often defined as investing in companies with stable year-over-year earnings growth and low financial leverage. Also speaking during the session, Dustin Haygood, client portfolio manager at Aristotle, said that approach creates a highly concentrated and not very diverse portfolio.
Instead, he said it’s important to determine whether a company is “in control of its own destiny” or if its success is only due to factors outside of its control; whether it has large scale and strong brands; whether customers would face high switching costs to leave the company; and if people are willing to pay for its product for reasons beyond just the price.
Taking a “qualitative approach” to quality investing also allows for not just sector diversification but geographic diversification, as quality indices are often heavily weighted toward the U.S. While U.S. equities have outperformed international equities over the past 14 years, that has started to shift in the past few years. Quality international equities are also less likely to be trading at high multiples: international equities on the whole trade at roughly a 30 per cent discount to U.S. companies, yet their dividend yield has been increasing relative to U.S. stocks.
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Haygood said Aristotle Capital doesn’t have specific financial metrics or a screening process for quality companies, as they aren’t necessarily indicative of a company’s future trajectory. However, Sufi said how a company treats its employees is an important metric.
Both Haygood and Sufi also stressed it’s important that investors only invest in companies with business models they understand. “It’s not in the buying or the selling, but in the waiting and really understanding what great businesses are, how they’re going to improve over the long term and not trying to predict what’s going to happen or make a bet,” said Haygood.
Read more coverage of the 2023 Defined Benefit Investment Forum.