Investing for stability: How high quality companies can protect you during turbulent times

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In a world where uncertainty seems to be the only certainty, investors are constantly searching for solid ground. From geopolitical tensions to technological disruption, from inflation worries to recession fears, it often feels like we're navigating through a perfect storm of unknowns.

But here's the good news: high quality, income-generating companies have a proven track record of not just surviving, but thriving through uncertain times. We spoke to the team behind the STS Global Income and Growth Trust about why these companies might be exactly what your portfolio needs right now.

How high quality companies weather the storm

Think of high quality companies as ships built for rough seas. While other boats might capsize in stormy weather, these vessels are designed to handle whatever Mother Nature throws at them. But what exactly does “high quality” mean in an investing context?

“The key characteristic that makes a company high quality is a high return on capital employed,” explains James Harries, Senior Fund Manager on the STS Global Income and Growth Trust.

In other words, it means you’re getting the most bang for your buck - the company can generate more profit from the money it has invested in its business than other companies in the same industry. Analysts consider it a sign of good management and smart business strategy. 

“High quality companies can sustain high returns owing to having certain competitive advantages such as brands, scale benefits or being the lowest cost producer. This enables the company to fend off competition to the benefit of their shareholders.”

Let’s look at some examples of advantages that high quality companies have that help elevate them above their competitors.

What sets high quality companies apart

Strong balance sheets = staying power

When uncertainty hits, cash is king. Quality companies typically have:

• More cash than debt

• Steady cash flows that endure during tough times

• The ability to fund operations without taking out loans

• Flexibility to invest when others are struggling

These characteristics enable businesses to continue operations without external borrowing, quickly convert assets to cash if needed, and remain flexible in strategic decision-making. Ultimately this protects the company's financial stability and gives it the ability to adapt to economic challenges.

Pricing power = inflation protection

Worried about inflation? Quality companies have a secret weapon: pricing power. When costs go up, they can raise prices without losing customers. For example, you probably wouldn’t switch toothpaste brands just because Colgate costs 3 pence more per tube. That's pricing power in action.

Strong pricing power allows businesses to maintain profit margins during inflationary periods, protects revenue, and signals a robust competitive advantage that can ensure sustained financial performance.

Essential products = recession resistance

The best quality companies typically have perennial appeal. That is, they sell things or offer services that people always need, not just what they want. Whether the economy's booming or busting, most people will still ensure they’re able to afford:

• Staple foods, such as rice, sugar, oil, butter, milk, and salt

• Medical supplies, like bandages, plasters, hand sanitiser, disinfectant, and antibiotics

• Household goods, such as toilet paper and cleaning supplies

Companies which sell essential products benefit from consistent demand regardless of economic conditions. These goods remain necessary for day-to-day life, providing stable revenue and protecting the business from wider market volatility.

Wide moats = protection from disruption

Quality companies also have strong competitive advantages - or "moats" as famed investor Warren Buffett calls them. This is the strategic edge that protects it from rivals, similar to a medieval castle's protective moat, such as:

• Strong brand recognition

• Unique technology

• High barriers to entry for competitors

• Network effects

• Cost advantages

• Powerful intellectual property

A wide moat gives a company a durable competitive advantage, protecting its market position while also making it difficult for competitors to erode its profitability and market share over time.

The role of income when markets are shaky

Many high quality companies share their profits with shareholders through regular payments called “dividends”. These can provide investors with a steady income stream while potentially signalling the company's financial health and stability.

It’s an attractive feature for those seeking consistent cash returns, adding a layer of certainty to your investment portfolio. While stock prices might bounce around, dividends from quality companies tend to be steady and often grow over time. It's like having a reliable paycheck from your investments.

“Income-generating companies, because they pay a regular dividend, tend to be conservatively managed and financed and are generally reasonable value,” he explains. “Further, investors can use the income they produce to cover living expenses without having to dip into capital at inopportune moments. Investors can therefore withstand the inherent volatility of equity markets with greater equanimity. This splitting of income and capital is a very old and well-established concept.”

Why income investing is regaining appeal

Although recently we’ve seen an explosion in popularity of growth investments – think businesses in emerging industries or with innovative strategies with the potential to deliver large gains over long periods of time – income investing is starting to make a comeback.

“As you say recent years have been dominated by large growth companies which has made income investing look less appealing,” Harries concedes. “However, in our experience, income investing becomes more or less attractive depending on what recent returns have been.”

“When times are good, as they have been recently, the certainty of income becomes overlooked. If we do have a more volatile period with lower returns, investors may be reminded of why generating some income from their investments has merit.”

Harries thinks that growing concerns around the overconcentration of tech growth stocks in the major stock markets is starting to make investors rethink their strategy. With rumours of a “tech bubble” on the horizon, now could be a good time to shift focus and invest in companies which prioritise a steady stream of income over the long-term.

“Given that US equity markets are now very concentrated and trading at elevated valuations relative to history, it may well be a sensible time to reinvest a proportion of those strong capital gains to secure a long-term growing income stream from hard-earned savings.”

What strategies are quality fund managers employing for 2025?

The world of investing in 2025 is looking tricky already. Fund managers are scrambling to protect their portfolios amid geopolitical tensions, potential economic hiccups, and ongoing inflation and the efforts of central banks to play their fiscal cards right. Many fund managers are focusing on spreading investments wider, leaning into safer sectors, keeping more cash on hand, and hunting for high quality companies that can weather the storm.

At STS Global Income and Growth Trust, the investment team are sticking with their long-held preference towards consumer staples and are moving into 2025 with caution as we wait to see how the year unfolds.

“Troy Asset Management, the manager of the STS Global Income & Growth Trust, is a conservative investment house that seeks to consider the downside as well the upside to investments. In this way, we aim to produce decent returns with below average volatility.”

“We are defensively positioned with a material allocation to sectors such as consumer staples and healthcare, which we view as high quality but should also be resilient in a downturn,” Harries says. “Interest rates have risen further and faster than they have for 40 years. This is likely to have an effect on economies, but with a long variable lag. We think this process is ongoing. That this is happening at a time of highly concentrated and fully valued equity markets to us demands a cautious approach.

“We think a high quality, low volatility, conservatively managed global income portfolio is well suited to this environment. As long-term investors, we have not made specific changes to the portfolio but have been establishing new investments in companies that we see as high quality and good value. Examples include airline IT company Amadeus and pest control business Rentokil Initial. We also have a number of ideas in a range of more cyclical industries such as industrials, non-bank financials and consumer discretionary companies which we deem currently to be too expensive, but which would be excellent candidates for the portfolio should we see market weakness.”

Smart investing for precarious times

High quality, income-generating investments could be a smart investment strategy for 2025 because they offer stability during uncertain times. By targeting companies with strong balance sheets, consistent dividend yields, and proven resilience, investors can potentially protect their capital while generating steady returns. 

Of course, as is always the case when it comes to investing, nothing is guaranteed and there is always the risk that you will get back less than what you put in. However, high quality investments provide a defensive approach that can go some way to mitigate market volatility and protect against economic slowdowns.