The quality puzzle

Jun 2, 2019

by <a href="https://www.fostergroup.ca/author/michael-nairne/" target="_self">Michael Nairne</a>

by Michael Nairne

Michael Nairne, CFP, RFP, CFA, is the president of Tacita Capital Inc., a private family office in Toronto.

Why do markets reward investors for holding stocks that usually provide excess returns over low-quality ones?

Of all the factors associated with long-term outperformance by equities, quality is the most puzzling. Because investors demand a return premium for incurring risk, it is easy to understand why small company stocks have outperformed over long time frames: they are more volatile and less liquid than large-capitalization stocks.

Value stocks – which tend to have more debt, slower growth rates and higher costs of capital than growth stocks do – also have earned a value premium over the long run. But why should markets reward holders of quality stocks with excess returns over those holding low-quality stocks? It is counterintuitive

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