GARP different

How GARP Crashed the Growth vs. Value Party


The Barron’s 400 Index (B400) completed its most recent semi-annual rebalance on Friday, March 19th. In replacing 167 of its constituents and retaining the remaining 233, it restocked its roster with Financials (80 companies), Technology (78 companies), Consumer Discretionary (76 companies), and Industrials (64 companies), which round out its top four sector exposures. Investors unfamiliar with B400’s selection methodology might be surprised to see a similar number of stocks selected to otherwise opposing themes in the current “market rotation” discussion; namely, Technology (and to a lesser degree Consumer Discretionary) on one hand (growth stocks) and Financials and Industrials on the other (value stocks). For investors who have followed B400 since it launched in 2007 on the cover of Barron’s, this sector breakdown is classic B400.

(For more on the rebalance of the Index and the ETF that tracks it, BFOR, please see here.)

Are Growth and Value Trading Places?

As investors are now reminded almost hourly, growth has outperformed value pretty massively in the last 10 years. An investor with perfect foresight choosing growth over value 10 years ago (as measured by the Russell 3000 Growth and Russell 3000 Value Indexes) would have gained an advantage of 78 percentage points, or 7.8% advantage per year on average (which differs from annualized returns), assuming he had stayed fully invested in U.S. equities throughout the decade[1]. This advantage in favor of growth was also present in the last year, during which the Growth benchmark outperformed the Value benchmark by 8%, excluding dividends. Since September, however, roles have clearly reversed, with the Value index outperforming the Growth index by 13%[2]. Is this rotation out of growth and into value set to continue and establish a new market trend? We have no idea, just like we’d venture to say that few investors knew the extent to which growth would outperform value 10 years ago. It is for such investors, who lack perfect foresight, for whom B400 was created. Based on its GARP-based methodology, succinctly explained by Barron’s editors at the time of its launch, B400 was designed simply to harness the growth of “America’s most promising companies” by identifying those that grew at above average returns and had solid business franchises (as measured by the strength of their fundamentals), without overpaying for their shares.

In the last 10 years B400 has perfectly straddled the growth vs. value divide, gaining 186% (excluding dividends), trailing growth by 115 points but outperforming value by 63 points, as can be seen in Figure 1. For context, an investor tracking the S&P 500 Index (which leans towards the large cap growth benchmark because of its market cap weighting) would have gained 201%, also excluding dividends. Alternatively, an investor interested in owning the S&P 500 Index that was concerned with concentration risk, could have tracked the equally weighted version of the index and gained 185%, a mere point behind B400. Lastly, an investor interested in B400’s GARP approach but wanting a large cap exposure, could have chosen the market cap-weighted version of B400, and gained 246%, outperforming the S&P 500 Index by 45% (there is currently no investment product available to investors tracking the market cap weighted version of B400, by the way). The 10-year returns for all these are illustrated in Figure 2.

Figure 1. 10-Year Cumulative Price Return of B400 vs. Growth and Value

Based on cumulative price returns measured from March 21, 2011 through March 19, 2021. Source: Bloomberg

Figure 2. 10-Year Cumulative Price Return of B400 vs. Market Benchmarks

Based on cumulative price returns measured from March 21, 2011 through March 19, 2021. Source: Bloomberg

A GARP Alternative to Perfect Investor Foresight

The hypothetical investor with perfect foresight described above, who selected growth over value a decade ago, would have obviously also rotated into value six months ago. In doing so, he would have gained a 13-point advantage in a mere half year, based on a 15% price return for the Russell 3000 Growth Index compared to 28% for the Russell 3000 Value Index. For context, such investor might have also chosen to own the S&P 500 Index, and gain 18%, or its equally weighted sibling, which rose 29% in the last six months. A purely passive investor might have chosen to track the Russell 3000 Index, which had a 21% price gain. An investor without perfect foresight, unable to predict the winner between growth and value could have, as described before, chosen to track B400, which had a six-month return of 35%[1].

Based on the above, one might assume B400 started outperforming the market when the growth to value rotation started during the fourth quarter of 2020. That wasn’t the case, though. The Index had a full year return (since March 2020) of 105%, outperforming not only the Value benchmark by 32% but also the Growth benchmark, by 23%. And it did better than a purely passive approach, as measured by the Russell 3000 Index, which gained 78%. This may be seen in Figure 3.

Figure 3. 1-Year Cumulative Price Return of B400 vs. Market Benchmarks

Based on cumulative price returns measured from March 20, 2020 through March 19, 2021. Source: Bloomberg

B400’s outperformance may be partly explained by the strong performance of small cap stocks in the last year, with the Russell 2000 Index gaining 126% (49% alone in the last six months), though rotating into small caps (or increasing an allocation to them significantly) would also have required foresight. However, the small cap overlap between B400 and the Russell 2000 Index is pretty minimal, suggesting the small cap bias theory as explanation for B400’s performance is incomplete at best. For example, the largest stock in the Russell 2000 Index, Plug Power Inc. (PLUG), has a market cap of $19.5 billion, whereas 157 companies in B400, or 39% of its constituents, have a market cap greater than that. At the bottom end of the size spectrum, B400 only has 17 constituents with a market cap below $1 billion, accounting for 4% of the names and 4.7% of the Index weight. The Russell 2000 Index, on the other hand, has 905 companies below the $1 billion threshold, accounting for 45% of its constituents and 12% of its weight (since it is a market cap weighted index).

Our unscientific explanation for B400’s performance is rather simple; it owns the country’s best performing companies, which have proven, over time, to do better than the average in delivering investment returns. No, the index will not beat all the benchmarks all the time and will often underperform the size or style benchmark, depending on what the market is favoring at the time. But, as shown above, riding the style or size waves with perfect timing all the time requires perfect foresight, which obviously no investor has. Some active managers do, indeed, outperform by ‘seeing around corners’ and anticipating trends, changes in market cycles, and simply by superior stock selection. The challenge for investors is to find them and stick with them in the long run. B400, we argue, offers a great alternative to that.

[1] Based on cumulative price returns measured from March 20, 2020 through March 19, 2021. Source: Bloomberg.

[1] Based on cumulative price returns measured from March 21, 2011 through March 19, 2021. Source: Bloomberg.

[2] Based on cumulative price returns measured from September 18, 2020 through March 19, 2021. Source: Bloomberg.

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