When I first started studying systematic factor investing, I was convinced that finding high-quality companies at reasonable prices was an unbeatable formula. If you systematically buy profitable, low-debt businesses at a discount, shouldn't you naturally outperform the broader market index over time?
To test this assumption, I analyzed a comprehensive 15-year backtest study evaluating a value-and-quality fund strategy across 5,368 companies in the US, Canada, and Europe from April 2011 to October 2026. The study tested 37 distinct rule variations—ranging from quality floors and momentum gates to market-trend defenses and valuation regimes—to see what truly drives market outperformance.
The results provide a sobering and insightful look into how systematic strategies perform against major benchmarks like the S&P 500 and global large-cap equities. Let's break down what the data reveals about risk, return, and portfolio engineering.
The Core Foundation: Disciplined quality investing excels at managing downside risk and improving risk-adjusted returns (Sharpe ratio), but outperforming a cap-weighted index dominated by high-growth megacaps is far harder than most investors expect.
The Head-to-Head Baseline Results
The baseline strategy ("Today's Rules") combines quality and value stock selection with a 70% style rotation and a Shiller CAPE valuation regime (shifting defensively when CAPE exceeds 25).
Over the 15-year backtest period (in euros, dividends included), here is how the core strategies stacked up against the benchmarks:
| Strategy / Benchmark | Annual Return | Volatility | Worst Drawdown | Sharpe Ratio | What €100 Became |
|---|---|---|---|---|---|
| S&P 500 Index | 16.0% | 13.4% | -18.9% | 1.20 | €1,003 |
| The Fund (Today's Rules) | 15.5% | 11.5% | -18.4% | 1.35 | €941 |
| Quality Rules Alone | 15.1% | 13.3% | -21.1% | 1.15 | €804 |
| World Large Caps (MSCI World Stand-in) | 14.7% | 12.8% | -17.8% | 1.15 | €826 |
Key Takeaways from the Headline Numbers
- Beating the World, Trailing the S&P 500: The fund's optimized rules achieved an annualized 15.5% return, comfortably beating the global large-cap benchmark (14.7%) while trailing the US-heavy S&P 500 (16.0%).
- Superior Risk-Adjusted Performance: While the S&P 500 delivered a slightly higher absolute return, the fund achieved significantly lower annual volatility (11.5% vs. 13.4%), yielding a superior Sharpe ratio of 1.35 (compared to 1.20 for the S&P 500).
- The S&P 500 Drag: The S&P 500's performance over this era was heavily driven by a handful of mega-cap tech giants that rarely pass strict valuation or margin-of-safety filters. A disciplined fund holding mid-sized European and North American stocks naturally faces structural tracking variance against a US mega-cap index.
5 Crucial Insights from Testing 37 Rule Variations
The study tested 37 different adjustments to the investment process—ranging from trailing stops to ROIC (Return on Invested Capital) floors. Out of 37 variations, 18 beat global large caps, but almost none beat the S&P 500 on absolute returns.
- Complex Rule Modifications
- Increased Friction
- Lower Absolute Returns
- Quality + Defensive Rotation
- Reduced Volatility
- Higher Sharpe Ratio (1.35)
1. Most Rule Adjustments Made Performance Worse
Sensible ideas like looser quality floors, momentum gates, trailing stops, or moving to cash during downtrends frequently hurt overall returns. For instance, implementing a 20% trailing stop reduced annual returns from 15.1% down to 12.2%, as false sell signals cut off recovery rallies.
2. Risk Is Easier to Improve Than Return
While few rules raised absolute returns above the S&P 500, several rules successfully curtailed downside volatility. Rotating part of the portfolio into defensive, high-dividend quality stocks during market drawdowns successfully eliminated roughly two-thirds of the market's falling months.
3. Loosening Quality in "Cheap" Markets Cost Money
The study tested Shiller CAPE valuation regimes that loosened quality requirements when the market appeared cheap (e.g., CAPE below 18 or 25). Every single rule that lowered quality thresholds during cheap valuation regimes reduced long-term returns—proving that buying lower-quality businesses during market dips hurts compound performance.
4. Review Timing Introduces Hidden Noise
One of the most striking findings was the impact of the rebalancing schedule. Running the exact same rules with a annual review in January versus July changed the annualized return by up to 3.6 percentage points per year. This highlights that many apparent "alpha" signals in backtests are simply statistical noise tied to review dates.
5. Quality Alone vs. Style Rotation
Relying purely on quality rules without dynamic rotation produced a 15.1% return with 13.3% volatility (Sharpe 1.15). Adding a 70% style rotation and CAPE defense reduced volatility to 11.5% and boosted the Sharpe ratio to 1.35, proving the value of multi-factor risk controls.
Portfolio Construction and Systemic Constraints
Understanding the operational rules behind the backtest explains its real-world feasibility and limitations:
- Equal-Weight Sizing: The fund enters positions at equal weights and allows winners to run. Stocks are sold only when explicit exit rules trigger, with proceeds reinvested into top-ranked candidates.
- Transaction Costs & Cash Yields: Trades account for a realistic 0.1% transaction fee, and uninvested cash earns the official ECB deposit rate.
- Sector & Data Exclusions: Because financial database coverage varies, financial institutions (banks and insurers) were excluded due to unstandardized ROIC metrics.
- Hindsight Flattery: Every rule was tested over a specific historical period (2011–2026). In live forward-testing, investors should reasonably expect lower real-world outperformance due to regime changes.
Ready to Take the Next Step?
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