THE GARP STRATEGY
Growth at a Reasonable Price (GARP) is a well-known, much-practiced investment approach. It is a fundamental-driven investment strategy that balances pure growth and pure valuation, as the former tends to invest in high-growth, yet expensive stocks, while the latter may take a long-term investment to pay off. Primarily, the GARP strategy favors investing in companies with consistent earnings and sales growth, reasonable valuation, and solid financial strength, combined with strong profitability. The underlying investment thesis of the S&P 500® GARP Index seeks to track the GARP strategy and earn higher risk-adjusted returns than its underlying universe over a long-term investment horizon.
In this paper, we introduce the S&P 500 GARP Index, its strategy, construction methodology, risk/return profile, factor exposures, and attribution analysis.
ESTABLISHING THE MULTI-FACTOR FRAMEWORK
We use a systematic bottom-up approach for stock selection and portfolio construction (see Exhibit 1), which we summarize as follows.
- Define the investment universe (the S&P 500).
- Identify factors with the potential to fulfill the GARP investment strategy.
- Select sensible factors for multi-factor metrics.
- Select constituents with well-defined rules.
- Construct a constituent portfolio with a predefined weighting methodology.
We use three-year EPS and SPS growth metrics to capture a firm’s growth. In order to maintain sustainable growth, a firm needs to be highly profitable (high ROE) and not have excessive leverage (low financial leverage ratio). We also use the earnings-to-price ratio to gauge a firm’s reasonable valuation. These factors effectively enact the characteristics of the GARP strategy.
