Introducing the Global X S&P World ex Australia GARP ETF (ASX: GARP)
In the vast and dynamic world of investing, striking a balance between growth and value is a challenge that investors may face. Sometimes the pendulum switches between these two different styles of investing with one being in favour over another. The length of the divergence could be months, years or potentially decades, as evidenced by growth’s strong outperformance over value since the Global Financial Crisis (GFC)1.
For investors seeking to capture the potential upside of growth while mitigating the risks associated with overvaluation, the Growth at a Reasonable Price (GARP) investing strategy presents a compelling approach. This investment philosophy blends the pursuit of companies with robust growth prospects and the discipline of value investing. This strategy could unlock the opportunity to find companies that can grow their earnings and revenues but are also trading at reasonable valuations.
Key Takeaways
- Global developed share markets, like the US, are currently trading above their historical long-term average valuations2, potentially prompting investors to seek out companies with robust earnings growth and solid financial strength that are fairly priced.
- GARP investing has historically outperformed a broad share market index over multiple rolling periods and has had higher risk-adjusted returns3.
- GARP can serve as a core equity strategy in portfolios, effectively balancing growth and value across different market cycles, and delivered at a lower cost compared to traditional actively-managed growth funds.4
What is GARP Investing?
GARP investing sits at the intersection of growth and value investing. The key is finding companies that are not only growing their revenues and earnings, but also reasonably valued in relation to their growth.
The origins of GARP can be traced back to legendary investors like Peter Lynch, who popularised the strategy in the 1980s. Lynch’s success with the GARP approach in his Fidelity Magellan Fund demonstrated its effectiveness in capturing returns while managing the inherent risks of growth investing, as the fund returned on average 29% p.a. making it the best-performing mutual fund in the world during his tenure5.
Investors may want exposure to highly quality companies that have strong growth characteristics but may also be concerned about companies trading on lofty valuations. On the other hand, just because a company is trading at a low valuation, doesn’t necessarily make it a good investment. Things can stay cheap for a reason as Warren Buffett wisely noted, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” GARP investing goes beyond seeking “cheap” companies by incorporating both growth and quality factors to ensure it targets strong fundamental businesses.
Price Conscious but Not Compromising Quality
For Australian investors, the allure of GARP lies in its ability to provide exposure to high-quality global companies that are growing, without venturing into speculative territory. The strategy is particularly relevant in today’s market environment, where valuations in certain areas have risen to reasonably high levels. The Cyclically Adjusted Price to Earnings (CAPE) Ratio for the US market appears elevated, trading more than one standard deviation above its long-term average. The last time we saw valuations stretched to similar levels was during the great depression, the dot-com boom and the most recent inflation shock.
By focusing on companies with solid fundamentals and reasonable valuations, GARP offers a balanced approach to global equity investing, enabling investors to remain invested whilst simultaneously maintaining a disciplined approach to valuation. During times of high valuations, the short-to-medium-term forward returns tend to be less favourable compared to periods with lower multiples.
Over the short-term, psychology drives markets through valuations and market expectations. However, over the long-term, earnings matter. A company’s earnings growth is the engine that drives long-term wealth creation, as earnings have accounted for the majority of total shareholder return over the past 20 years, compared to the smaller portion derived from dividends and multiple expansion.6
How to Find GARP Stocks
Companies that exhibit GARP characteristics have a combination of factors relating to growth, quality and value. Investors can screen for global companies listed on the share market using some of the below metrics as a filtering mechanism.
However, consistently monitoring these stocks and applying up-to-date screening can be cumbersome. Some active fund managers may attempt to adopt the GARP investment style but may charge higher fees compared to low-cost index funds. This is part of the reason why over 90% of active Australian-listed global equity fund managers have underperformed a broad market index over the long-term.7
Adopting a GARP framework to investing can provide exposure to companies that have better revenue and earnings growth, lower levels of leverage, higher return on equity, and solid profit margins, whilst all trading at reasonable valuations.
GARP investing can make it easier for investors to own reasonably-priced companies in high-growth sectors without the need for them to constantly rotate stocks themselves, which can be challenging due to shifting business and economic cycles. As companies mature or face changing environments, a rules-based GARP approach adapts, allowing investors to outsource the stock rotation decision to a rules-based index methodology to try to keep in sectors with strong growth. For example, energy stocks had higher growth rates after the GFC due to an economic recovery, while technology stocks gained prominence during the COVID-19 pandemic.
Focusing on strong, high-performing businesses while being price-conscious has also historically enabled the GARP investing strategy to outperform the broader benchmark over multiple rolling year periods, with higher risk-adjusted returns.
Although market cycles may favour individual factors like growth, value, quality, low volatility or company size at different times, predicting which will outperform can be challenging. This uncertainty may lead investors to prefer a more balanced approach, such as a GARP investing strategy.
The Best of Both Worlds
By focusing on quality companies with sustainable earnings growth and reasonable valuations, GARP allows investors to participate in global growth trends using a value-driven approach. In an era where growth stocks often dominate headlines, GARP reminds investors of the importance of valuation discipline. By carefully selecting companies that meet the criteria of growth at a reasonable price, Australian investors can build a diversified global portfolio capturing growth while safeguarding against the pitfalls of overvaluation.
GARP investing is not just a middle ground between growth and value; it is a thoughtful strategy that combines the best of both worlds. For those looking to invest in global companies with consistent fundamental growth, solid financial strength, strong earnings power and trading at reasonable valuations, GARP provides a compelling case for consideration.
3 Reasons to Consider
- High Growth at Fair Value: Exposure to companies with robust earnings growth and solid financial strength trading at reasonable valuations.
- Broad Global Diversification: Gain diversified exposure to approximately 250 companies spread across multiple countries and sectors.
- Disciplined, Low-Cost Approach: Access a strategy balancing both growth and value investing, with potential outperformance over a broad global share market at a competitive management fee.
Related Funds
GARP: The Global X S&P World ex Australia GARP ETF (ASX: GARP) provides investors with exposure to global companies with strong earnings growth, solid financial strength, and trading at reasonable valuations.