Quality Factor Across Market Caps and Sectors: A Consistent Performer
Over the past decade, the Quality factor has gained remarkable recognition globally. In the US alone, the quality-focused smart-beta ETFs AUM surged from just $4,672 million in December 2014 to over $100,000 million by December 2024, growing at an impressive 35.9% p.a., the highest among all factor strategies (Source: Bloomberg).
This growing preference for quality is not confined to global markets. In India, too, as investors increasingly seek consistency, resilience, and strong fundamentals, quality-focused investing is steadily creating a space for itself. But a key question remains — does the Quality factor truly deliver across sectors and market capitalizations?
What Makes Quality a Winning Factor?
The Quality factor is all about identifying companies with strong fundamentals: solid balance sheets, high and stable earnings, low leverage, good governance, and financial resilience.
In today’s fast-moving markets, this approach helps investors avoid companies that may appear promising but lack the durability to withstand downturns. By focusing on businesses that consistently deliver, quality investing aims to reduce risk while still capturing growth.
Quality across Market Caps
No matter the market cap, quality acts as a powerful filter, separating enduring businesses from the rest. What differs, however, is the impact of quality across these segments.
| Market Capitalisation | Portfolio | CAGR (%) | Annualized Volatility (%) | Max Drawdown (%) | 5 Year Probability of Loss (%) | Median Rolling Return | |||
| 1 Year | 3 Year | 5 Year | 10 Year | ||||||
| Large Cap | Top Tercile based on Quality | 13.29 | 17.60 | -55.22 | 0.02 | 12.84 | 14.77 | 13.91 | 13.94 |
| Middle Tercile based on Quality | 12.32 | 21.38 | -66.30 | 1.72 | 11.39 | 13.66 | 12.05 | 12.88 | |
| Bottom Tercile based on Quality | 11.62 | 24.81 | -75.09 | 11.23 | 11.32 | 13.19 | 11.07 | 11.28 | |
| Large Cap | 12.64 | 20.60 | -66.39 | 0.86 | 11.57 | 13.74 | 12.12 | 12.93 | |
| Mid Cap | Top Tercile based on Quality | 18.27 | 17.07 | -63.17 | 0.00 | 17.65 | 19.65 | 20.11 | 20.21 |
| Middle Tercile based on Quality | 15.02 | 21.27 | -69.23 | 0.27 | 12.77 | 17.68 | 15.06 | 16.62 | |
| Bottom Tercile based on Quality | 8.28 | 24.98 | -80.39 | 27.45 | 6.85 | 9.28 | 6.77 | 6.92 | |
| Mid Cap | 14.05 | 20.50 | -71.61 | 1.51 | 12.05 | 15.78 | 13.67 | 14.96 | |
| Small Cap | Top Tercile based on Quality | 18.01 | 18.29 | -63.35 | 0.00 | 15.14 | 21.78 | 20.38 | 20.81 |
| Middle Tercile based on Quality | 12.39 | 22.17 | -73.19 | 4.47 | 13.53 | 17.87 | 11.30 | 14.17 | |
| Bottom Tercile based on Quality | 8.28 | 24.57 | -75.66 | 18.28 | 4.95 | 10.28 | 6.01 | 7.62 | |
| Small Cap | 13.04 | 21.18 | -71.24 | 2.53 | 10.98 | 16.81 | 12.62 | 14.24 | |
Data for the period September 30, 2006, to February 28, 2025. Quality is measured based on a combination of ROE, Dividend payout ratio and debt-to-equity. Portfolio is rebalanced yearly on 30th September. Top 100 Companies based on Free Float Market Cap on the date of rebalance are classified as large cap, while 101 to 250 are classified as mid cap, and the remaining stocks from Nifty 500 are classified as small cap. Insurance companies are excluded. All portfolios shown above are back-tested models and the returns may or may not replicate in real life. Portfolios or methodologies mentioned above should not be considered as a recommendation by NJ Asset Management Private Limited. Past performance may or may not be sustained in future and should not be used as a basis for comparison with other investments.
Large Caps: Stability Over Spectacular
Large caps are typically seen as safer bets, but quality still makes a noticeable difference. Top-quality large caps delivered a 13.29% CAGR, higher than the broader large-cap return of 12.64%. More importantly, they had significantly lower drawdowns, showing that avoiding big losses is just as crucial as chasing big gains.
Mid Caps: The Sweet Spot for Quality Compounding
In the mid cap segment, quality plays an even bigger role. Top-quality mid caps posted a CAGR of 18.27%, far ahead of the broader mid-cap return of 14.05%, and did so with lower volatility and zero loss probability over five years. Financial discipline combined with high growth potential makes quality mid caps powerful engines of wealth creation.
Small Caps: Where Quality Matters Most
In the small-cap segment, the difference quality makes is the widest. Top-quality small caps delivered 18.01% CAGR versus 13.04% for the overall small-cap segment. Even in this volatile space, top-quality names showed better resilience during downturns, highlighting that in smaller companies, quality is not just important, it’s critical.
Across all market caps, the story is consistent: quality consistently leads to better outcomes. Whether aiming for stability or growth, keeping quality at the core of investment decisions can meaningfully improve long-term results.
Quality across Sectors
While the Quality factor has proven its strength across market capitalizations, a deeper look across sectors paints an equally compelling picture.
| ANALYSIS OF HIGH & LOW QUALITY COMPANIES ACROSS SECTORS | |
| Total No. of Sectors | 19 |
| No. of Sectors Where High Quality Stocks Outperform Low Quality Stock | 15 |
| No. of Sectors Where High Quality Stocks Are Less Volatile Than Low Quality Stocks | 19 |
| Average Quality Alpha Across Sectors (5Yr Rolling Median) | 5.39 |
| Median Quality Alpha Across Sectors (5Yr Rolling Median) | 6.5 |
| Average Quality Excess Volatility Across Sectors | -5.49 |
| Median Quality Excess Volatility Across Sectors | -4.49 |
Data for the period September 30, 2006 to February 28, 2025. Quality is measured based on a combination of ROE, Dividend payout ratio and debt to equity. Based on the proprietary sector classification of NJ Asset Management. Insurance sector is excluded.
The data across 19 sectors reveals a clear trend: in 15 out of 19 sectors, high-quality stocks outperformed the low-quality stocks. More impressively, high-quality stocks were less volatile than low-quality stocks in all 19 sectors.
Across sectors, the average Quality Alpha (the excess return of high-quality stocks over low-quality ones) stood at 5.39% based on 5-year rolling medians. At the same time, high-quality stocks exhibited 5.49% lower volatility across sectors on average, reinforcing that quality doesn't just deliver better returns but does so with greater stability.
| Market cap category | Portfolio | Annualised return (%) | Annualized Volatility (%) | Maximum drawdown (%) | 5Y loss probability (%) | Median rolling return | |||
| 1 year | 3 year | 5 year | 10 year | ||||||
| Consumer discretionary | Top half based on quality | 11.5 | 21.2 | -78.3 | 6.9 | 13.3 | 14.7 | 13.7 | 14.7 |
| Bottom half based on quality | 7.8 | 24.6 | -81.3 | 26.5 | 11.3 | 9.6 | 7.2 | 7.2 | |
| Consumer discretionary | 9.9 | 22 | -79.9 | 13.6 | 13.4 | 13.7 | 10.7 | 11.5 | |
| Information technology | Top half based on quality | 18.6 | 22.5 | -73.4 | 4.3 | 17.5 | 20.7 | 26.2 | 24.5 |
| Bottom half based on quality | 16.3 | 25.5 | -74.3 | 10.4 | 11.2 | 14.5 | 20 | 19.2 | |
| Information technology | 17.7 | 22.3 | -73 | 6.1 | 13.5 | 17.7 | 23.7 | 22.5 | |
| Diversified banks | Top half based on quality | 8.5 | 26.7 | -70.6 | 24.9 | 8.9 | 10 | 8.2 | 6.1 |
| Bottom half based on quality | 8.3 | 30.7 | -80.4 | 40.7 | 9.4 | 8.8 | 4.7 | 2.5 | |
| Diversified banks | 8.7 | 27.8 | -72.6 | 32.8 | 9.6 | 9 | 6.4 | 4.5 | |
| NBFC | Top half based on quality | 23.2 | 25.3 | -68.2 | 0 | 21.8 | 25.8 | 23.4 | 25.6 |
| Bottom half based on quality | 18.5 | 27.3 | -76.3 | 14.4 | 21.1 | 22.8 | 19.5 | 16.1 | |
| NBFC | 21.4 | 25 | -71.3 | 0.5 | 23 | 24.2 | 19.8 | 21.9 | |
| Financial services non-lending | Top half based on quality | 20.9 | 20.4 | -70.5 | 0 | 19.2 | 23.5 | 22.2 | 22.7 |
| Bottom half based on quality | 16.8 | 26.7 | -80.7 | 7.7 | 16.8 | 18.1 | 11.8 | 17.5 | |
| Financial services non-lending | 19.1 | 21.6 | -76.5 | 1.1 | 19.3 | 22.9 | 16.9 | 20.3 | |
| Automobiles and ancillaries | Top half based on quality | 15.1 | 19.8 | -65.6 | 2.9 | 17.3 | 21.7 | 20.7 | 17.9 |
| Bottom half based on quality | 15.5 | 23.4 | -79.1 | 6.1 | 15 | 16.2 | 20.5 | 19.3 | |
| Automobiles and ancillaries | 15.9 | 20.4 | -71.3 | 3.5 | 15.4 | 19.6 | 19.9 | 19.8 | |
| Industrials | Top half based on quality | 17.5 | 17.8 | -67 | 0 | 17.2 | 20 | 19.6 | 20.5 |
| Bottom half based on quality | 16.6 | 22.3 | -77.7 | 15.3 | 16.7 | 17.8 | 13.7 | 14.2 | |
| Industrials | 17.3 | 19.4 | -72.8 | 2.3 | 16.9 | 19 | 16.8 | 17.5 | |
Data for the period from September 30, 2006 till February 28, 2025. Quality is measured based on a combination of ROE, dividend payout ratio and debt to equity. Based on the proprietary sector classification of NJ Asset Management. All portfolios shown above are back-tested models and the returns may or may not replicate in real life. Portfolios or methodologies mentioned above should not be considered as a recommendation by NJ Asset Management Private Limited. Past performance may or may not be sustained in future and should not be used as a basis for comparison with other investments.
However, not all sectors stand equal when it comes to the quality advantage. Some industries offer particularly fertile ground for quality stocks to thrive:
- In sectors like Transport & Logistics, Chemicals, Consumer Discretionary, Infrastructure, and Financial Services (Non-Lending & NBFCs), high-quality stocks consistently outperformed with lower or similar risk.
- In Industrials and IT, quality stocks not only delivered higher returns but did so with smoother performance and lower drawdowns.
- Capital-intensive and regulated sectors like Energy, Metals, Real Estate, and Utilities, with more influence of external factors than company fundamentals, quality had a limited impact.
Thus, while the Quality factor demonstrates broad-based effectiveness, it tends to be especially powerful in sectors where the business models reward operational consistency, financial prudence, and governance excellence.
NJ AMC’s Quality-Focused Approach
At NJ AMC, we believe that quality is the cornerstone of long-term investing success, not just a passing strategy. Through our 100% rule-based investment process, we seek to eliminate emotional biases and systematically identify high-quality companies using parameters like ROE, leverage, earnings stability, and governance strength.
By focusing on businesses that stand out on these fundamental pillars, we aim to build portfolios that are resilient, growth-oriented, and align with investors’ long-term goals, regardless of market size or cycles.
Conclusion
Quality is a quiet, consistent force, compounding strength over time. For investors looking to stay invested through the noise and cycles, quality offers not just performance, but peace of mind.
The Quality factor doesn’t chase hype, it anchors itself in fundamentals that endure. Across sizes and sectors, it rewards discipline, durability, and sound governance.
In portfolios, quality isn’t just a filter — it’s your edge.
FAQs
1) What is the quality factor in investing?
The quality factor refers to selecting companies with strong fundamentals: high and consistent earnings, low debt, and sound governance, aiming to reduce risk and provide stable long-term returns.
2) What is the size factor in factor investing?
The size factor looks at companies based on their market capitalization: small, mid, or large. In investing, size can influence growth potential and risk, but it’s important to remember that successful investing is about more than just the size of a company.
3) How does NJAMC focus on quality in its investment strategy?
At NJAMC, our commitment to 100% rule-based investing ensures that quality remains the backbone of our approach, driving consistency, reducing risk, and building wealth for the long term.
Investors are requested to take advice from their financial/ tax advisor before making an investment decision.
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