After the Budget, Australia needs its own definition of quality

The headline was the overhaul of the capital gains tax regime, the replacement of the 50% CGT discount with cost-base indexation, alongside a 30% minimum tax on capital gains from 1 July 2027. The early debate has focused, predictably, on whether income or growth-oriented assets stand to gain. But that framing misses the point.

Tax regimes shape, over years, how markets price risk, resilience and shareholder return  and a change of this magnitude rarely just redirects flows. It revalues them.

This one will reveal, in time, something the Australian market has misunderstood for a long time: quality investing, as global investors define it, does not translate cleanly to Australia.

The signal itself is not the problem. Quality investing is one of the few market anomalies that has survived almost every academic and market stress test of the past three decades.

Eugene Fama and Kenneth French identified profitability and disciplined investment as persistent drivers of excess return beyond traditional value and size factors. Robert Novy-Marx later showed that gross profitability was one of the cleanest predictors of long-term equity performance, while the quality minus junk framework developed by Cliff Asness, Andrea Frazzini and Lasse Pedersen at AQR expanded the definition of quality across profitability, growth, safety and payout characteristics.

Those ideas underpin many of the world's most respected quality strategies today. MSCI's quality methodology, one of the global institutional standards for quality investing, systematically screens for companies with high return on equity, lower leverage and more stable earnings profiles. Over the past three decades, global quality strategies have consistently outperformed broader equity markets and exhibited the resilience investors expect during periods of economic stress.

Australia is structurally different

Australia's equity market is structurally cyclical. Financials and resources together account for close to half the S&P/ASX 200, making it one of the most concentrated developed markets in the world.

Traditional quality frameworks were built around stable return on equity, lower leverage and predictable earnings growth. Australia's market structure distorts all three. BHP and Rio Tinto will always be hostage to commodity cycles. The Big Four and Macquarie are leveraged by design. In a market this concentrated, quality portfolios inevitably become oversized stock and sector bets: by our analysis, the top 20 holdings account for roughly 73% of portfolio exposure versus 48% globally.

Eventually, the market structure overwhelms the factor. Globally, the MSCI World ex Australia Quality Index has outperformed its parent benchmark by more than 3 percentage points per annum since 1994 while delivering the resilience investors expect during periods of stress. Applied to Australia, the same frameworks have produced weaker and less consistent outcomes, with several pure quality strategies at times falling further than the ASX 200 during periods of market stress.

In a post-Budget market increasingly focused on resilience, tax efficiency and sustainable shareholder returns, those distortions matter even more.

What the market is rewarding

Australia is a poor market for pure factor investing hence we have been strong advocates of factor indifferent approaches by way of equal weighting. But that does not invalidate the underlying signal. Markets still reward businesses capable of generating durable free cash flow, protecting balance sheets and surviving periods of economic stress. That matters more in a world where capital is no longer free.

The defining feature of quality has never been spectacular upside. It has been survivability. Losing less in downturns matters more than outperforming in euphoric bull markets.

The Federal Budget may only accelerate that repricing. In a market where tax efficiency, resilience and sustainable shareholder return matter more, Australia increasingly needs a definition of quality built for its own market structure.

No single factor solves the problem in isolation. Quality becomes distorted by concentration. Value becomes a commodity bet. Growth becomes vulnerable when rates rise. Momentum whipsaws with the cycle. In concentrated markets, factors need to offset one another rather than operate independently.

The answer is not abandoning quality, but redefining it around resilience, valuation discipline and survivability. The result is a portfolio that still owns many of Australia's highest-quality franchises, but with very different convictions: less dependence on concentrated mega-cap exposures, and greater emphasis on resilient industrials, healthcare leaders, consumer franchises and businesses capable of compounding through the cycle.

The Budget has only reinforced the point. With the after-tax value of capital gains falling relative to franked income, markets will reward tax-efficient, sustainable dividend streams more highly. The problem was never the quality signal itself. It was the assumption that global frameworks would translate cleanly to a market like Australia.

As Howard Marks once observed: "It's more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favourable ones."

This op-ed was first published in the print edition of The Australian on Thursday 11 June 2026.