What is a quality fund?
A quality fund invests in companies with strong and sustainable business fundamentals and sound financials. These funds have the potential to deliver consistent long-term growth while withstanding market volatility.
“Fund managers use quantitative filters such as return on equity (RoE), return on capital employed (ROCE), earnings consistency, low leverage, and free cash flow strength. On the qualitative side, they assess management quality, corporate governance, competitive advantage (moat), resilience of the business model, and industry leadership,” says DP Singh, deputy managing director & joint chief executive officer (CEO), SBI Mutual Fund.
“This investment approach is market-cap and sector-agnostic, and relies on bottom-up selection,” says Shantanu Awasthi, co–founder & CEO, Mavenark Wealth. Portfolios also tend to have modest turnover and a long-term ownership bias.
Combine stability with growth
Quality funds aim to combine stability with growth for long-term wealth creation, while running relatively lower risk.
They offer downside protection. “Companies with strong balance sheets tend to fall less in market declines,” says Anand K Rathi, co-founder, MIRA Money. These funds invest in stocks with greater earnings visibility, thereby reducing uncertainty for long-term investors.
“They invest in businesses that rely less on external funding and economic cycles, which helps them navigate slowdowns and tight financial conditions,” says Rathi. Lower portfolio churn helps reduce transaction costs over time.
Feroze Azeez, joint chief executive officer (CEO), Anand Rathi Wealth, informs that insurance companies, which deploy long-term capital, tend to invest in quality stocks, which lends stability to them.
Valuation and other risks
Valuation is a key concern. “Avoiding overpaying for quality can be a challenge because quality companies seldom come cheap,” says Aarati Krishnan, head of advisory, PrimeInvestor.in.
Awasthi highlights another risk- the lack of a long-term track record because the category is still evolving in mutual funds.
Why they lagged in 2025?
Quality funds lagged the broader markets in 2025. The Nifty 200 Quality 30 Index delivered 4.7 per cent, compared with 11.9 per cent for the Nifty 50 total return index (TRI) and 7.8 per cent for the Nifty 500 TRI.
“The market environment favoured cyclical, high-beta and broader-market segments over steady high-quality names,” says Singh. Rathi points out that many quality portfolios avoided stretched or costly market segments, which hurt short-term performance.
Muted returns were also the result of valuation pressures in sectors such as fast-moving consumer goods (FMCG) and information technology (IT).
When do quality funds do well?
Quality funds tend to do well during periods of volatility, uncertainty, or slowing economic conditions. “Strong balance sheets, stable cash flows and proven business models can help quality stocks experience lower drawdowns in such phases,” says Singh.
Quality investing can also do relatively well in steady-growth or tight-liquidity environments where low leverage and disciplined capital allocation are rewarded. Rathi informs that quality funds also do well in sideways markets in which stock selection matters more than broad market momentum.
Over a full market cycle, quality funds can perform well, as stock prices reflect fundamental growth rather than short-term market trends.
When do they underperform?
Quality funds typically underperform in the early phase of a recovery, which is generally led by cyclical and high-beta equities. “The value factor performs best in the first leg when investors tend to be risk averse,” says Krishnan. She adds that quality funds also underperform in the last leg of a bull market when investors chase returns.
Quality, as a smart beta strategy, is one of the strongest among smart beta approaches because it focuses on three to four fundamentally driven factors rather than purely technical ones. “It suits long-term investors because for them a smart beta strategy should not rely only on demand–supply dynamics, but should also reflect the underlying fundamentals of a business,” says Azeez.
Long-term investors seeking sustainable gains from resilient, fundamentally strong companies may go for these funds. “Investors with a high-risk appetite who seek returns well above underlying earnings potential may find quality funds less suitable,” says Sharwan Goyal, fund manager and head – passive, arbitrage and quant strategies, UTI AMC.
Active or passive option?
Investors should choose between active and passive options based on whether they prioritise cost or conviction.
“Passive strategies offer a rule-based, low-cost structure that removes human bias,” says Goyal. Krishnan highlights that they can help investors avoid style drift risk and the risk of a change in fund manager.
However, passive strategies lack the qualitative insights that experienced active managers can bring. “Active fund managers look beyond financial statements and monitor shifts in competitive advantage,” says Goyal.
Active quality funds can apply filters such as management quality that cannot be reduced to quantitative screeners. They can also adjust portfolios proactively before changes reflect in numbers.
On the flip side, active funds seek alpha, but there is always the risk of their performance deviating from benchmarks.
Investors must have a horizon of five years or more for allocating to quality funds. How much an investor allocates to them should depend on their risk-taking ability, willingness and time horizon. Investors should adopt the systematic investment plan (SIP) approach to benefit from volatility and reduce the impact of market timing.
Finally, the quality style is linked to consumption-oriented companies with stable financials and growth prospects. “Government measures such as income-tax rebates and goods and services tax (GST) rationalisation are expected to support the outlook for quality-oriented companies,” says Goyal.
Pros and cons of value funds
Potential to deliver consistent long-term growth while withstanding market volatility
Combines stability with growth for long-term wealth creation with relatively lower risk
Offers downside protection because strong balance-sheet companies tend to fall less in market declines
Invests in stocks with greater earnings visibility, which can reduce uncertainty for long-term investors
Invests in businesses that rely less on external funding, which can help navigate slowdowns and tight financial conditions
Over a full market cycle, can perform well as stock prices reflect fundamental growth rather than short-term market trends
Disadvantages and risks
Carry valuation risk (risk of overpaying) because high-quality companies often trade at high valuations
Lack of a long-term track record because the category is still evolving in mutual funds
Short-term performance can suffer if portfolios avoid stretched or costly market segments
Typically underperforms in the early phase of a recovery led by cyclical and high-beta equities
Can underperform in the last leg of a bull market when investors chase returns.
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Periods
Nifty 200 Quality 30 Index
Nifty 50
1-year
4.2
9.8
3-year
13.7
13.1
5-year
10.5
11.4
3, 5 and 10-year returns are in CAGR.
Source: Bloomberg. Compiled by BS Research
The writer is a Mumbai-based independent journalist