International viewpoints: the quality derating

As with any investment, your capital is at risk.

Recent years have tested investors’ faith in quality growth as an investment style. Rising interest rates and ongoing concerns around tariffs have weighed heavily on many of the world’s most durable franchises. High-quality businesses across a range of sectors and countries, which had delivered profitable growth and stable share-price appreciation for many years, have recently fallen out of favour.

At the same time, capital has increasingly been directed towards low-duration, cyclical businesses and a narrow cluster of technology stocks closely associated with AI.

Quality-growth investing has been particularly challenging in 2025. In the nine months to 30 September, the median international quality-growth manager delivered a USD return of –13 per cent against a strongly rising market. This is consistent with stock-level price moves.

Many of our clients' longstanding outperformers have suffered, from Shimano, the Japanese leader in cycling components, and Rational, the German manufacturer of energy-efficient combi ovens, to the luxury group LVMH.

In some cases, earnings have disappointed and forecasts have been marked down; however, the overwhelming picture is one of unjustified derating. This presents opportunities for long-term investors, and we have been adding to some of our favourite quality companies and generating a healthy flow of new ideas. 

Our optimism towards quality businesses comes from the recognition that they take years to establish, are difficult to disrupt and, in our experience, can deliver above-market returns across cycles.

Defining quality

The MSCI Quality factor index includes stocks with high return on equity, low debt-to-equity and low earnings variability. These measures capture part of the story but are inherently backward-looking. 

At Baillie Gifford, we look forward. For us, a quality-growth company combines a long runway of opportunity with the ability and culture to exploit it. It's about inputs rather than outputs. Quality-growth businesses can compound earnings faster and for longer than the market expects, because their competitive advantages, balance sheets and management mindsets allow them to adapt, invest and persist.

The market-defying durability of quality growth businesses rests on three foundations: competitive advantage, resilience and stewardship. Competitive advantage is the moat that protects returns and enables reinvestment. Resilience allows companies to withstand shocks and emerge stronger. Stewardship, the alignment of management and owners, ensures decisions are taken with a long-term mindset.

We have historically found businesses that share these characteristics across very different sectors. For example, Danish enzyme manufacturer Novonesis has spent decades investing in research, development and manufacturing know-how. The result is dominance in a technology niche that underpins excellent financial returns and is likely to endure for decades.

Ryanair, by contrast, makes no claims on proprietary technology, yet it has consistently taken market share through a relentless focus on cost. Its average ticket price is lower than the average unit cost of its nearest competitor. With a stronger balance sheet and the newest, most efficient aircraft, its competitive advantage strengthens every year.

A final example is German exchange Deutsche Börse, which has roots dating back to the 16th century. Benefiting from a natural monopoly, it boasts outstanding cash flow characteristics and is positioned to capture consistent growth through the ongoing development of capital markets, generating profits whether shares are rising or falling.

Defying markets

The most successful quality-growth businesses can compound above-market returns for long periods of time by consistently reinvesting in growth at high returns on capital.

Traditional financial theory expects excess returns to fade as competition erodes advantage. Yet empirical evidence, supported by our own multi-decade experience of investing in international equities, suggests otherwise. Fewer than 4 per cent of global stocks have created all the net wealth in markets since 1990; many are quality-growth names that sustained superior economics for decades.

Quality companies do not merely survive downturns – they often emerge stronger, taking market share while weaker competitors retrench. While the market turns its back on quality growth stocks to chase shiny new things, we continue to seek out and treasure them. 

Risk factors

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in December 2025 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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