John Irving’s novel, The World According To Garp, is stuffed full of extra-marital sex, betrayal and sexual confusion. Thankfully, the investment style known as Garp – growth at a reasonable price – is a more straightforward and less traumatic story for fund managers to follow. Its basic premise is: buy growth stocks but don’t pay over the odds.
Jim Wood-Smith, chief investment analyst at London brokerage Gerrard, says the current interest in Garp-style funds is a direct result of the technology blowout in 2000, and he’s not overly impressed with the rising flurry of interest they’ve roused.
‘If you’re buying any stock you have to look at its valuation,’ Wood-Smith points out. ‘Well, roll out the red carpet and blow the trumpets. It’s really an admission that too many fund managers didn’t do this before.’
Glen Pratt, fund manager for the £60 mn ($101.7 mn) London-based Newton Growth Fund has a less abrasive view of Garp than Wood-Smith. ‘In one way or another, almost everyone is a Garp investor,’ he says. ‘Everyone wants to buy companies that grow and that are reasonably priced so yes, we are Garp investors – but we don’t necessarily style ourselves as exclusively as this type of investor.’
Despite what seems to be stating the blindingly obvious – only buy potential growth stocks if the valuations look sensible – a Garp approach does differ substantially from, for example, a value technique. The value approach generally involves buying defensive long-term plodders which are less immune to the gyrations of the market and an unpredictable world economy, and hopefully paying less for what you buy. Garp, on the other hand, is about paying less for an anticipated future updraft. Either way there is a multiplication of uncertainties.
An old friend
Rob Lay, client portfolio manager at JP Morgan Fleming, says Garp investment principles have actually been around much longer than some people give them credit for. ‘It’s very much a US import from a good ten to 15 years back,’ he explains, ‘though the tech boom did bring Garp into much sharper relief.’
Lay says JP Morgan Fleming’s own £80 mn ($135.6 mn) Global Equities Garp-style fund focuses on growth over the next three to five years; value investors, by contrast, are often prepared to wait more than five years before seeing significant returns. ‘We like good value stocks with good news flow attached to them,’ notes Lay. ‘Price momentum and benchmarking changes in price relative to the sector is one way we measure potential prospects.’
This out-and-out growth focus means no industry – from healthcare to banking to utilities – is barred from possible investment. Each sector is closely examined, with a fund manager drilling down to buy into the best-of-class company in each sector. ‘It’s basically taking analysis at a regional level and leveraging that into a global context,’ explains Lay.
But benchmarking Garp styles isn’t always straightforward. Different fund managers can pore over the figures with strikingly different colored marker pens. Sheridan Reilly, EVP portfolio manager for Schroders’ North America $4 bn international portfolio says he’s not just looking for high future growth. ‘We’re looking for situations where a company’s growth prospects might look modest or quite aggressive, but these are not accurately reflected in the price,’ he comments. ‘We want to understand the nature of future earnings growth and its quality and sustainability. Some Garp investment is in high growth companies that are trading on a discount, but a lot of our investment will be in companies with quite modest growth outlook and a stock price that discounts hardly any at all.’
What’s in a name?
Various other Garp investment strategies – or a pick-and-mix blend of several styles – are also popular, often supported by good cash flow history, attractive P/E ratios and shareholder-friendly boards. Paul Szczygiel, manager of David L Babson’s Small Company Opportunities Fund, appears to follow a Garp strategy, though he calls it Qarp, or ‘quality at a reasonable price’. Szczygiel is partial to companies with little or no debt and the potential to bring in over 15 percent annual earnings growth.
Jim Oberweis Jr, president of Oberweis Securities, follows another Garp variation, which he calls Agarp, or ‘aggressive growth at a reasonable price’. ‘As a general rule, I try to buy companies at P/E ratios of no more than half of their forward growth rate,’ Oberweis explains. ‘If I expect the company to grow at 60 percent, I acquire shares at no greater than 30 percent.’
And just to keep the alphabetical creativity going, there is also Marp (margin at a reasonable price). As Jon Horton from London-based financial advisers Chamberlain de Broe points out, defining exactly what type of Garp strategy a fund manager follows is crucial. ‘Is his or her analysis based on fundamental values, or technical?’ he asks. ‘The ‘tech’ approach won’t go near the ‘reasonable’ mark. It might well tell you to buy at ten when historically it’s been at 20, but if you’re buying at ten it might be because there has been a severe profits warning.’
A matter of style
Probably one of the best-known Garp investors is Jim Slater, a writer of several personal finance investment best-sellers. Slater is not terribly bullish in the medium term for stocks. But by bagging growth stocks carefully – even if the market gets tugged down in the long-term – Garp investors should pan out, he says. A cornerstone of his strategy is to focus on the P/E ratio expressed through a percentage of earnings growth from analysts (often taken with large dashes of salt). Plenty of cash flow and management buying heavily into the company are other good omens for buying in.
Although Garp investment strategies often tend towards robust sectors of an economy, picking up companies on the cusp of an earnings upturn, perhaps in an overlooked or largely ignored sector, is also part of the Garp technique.
Nevertheless, Robert Talbut, chief investment officer at Isis Asset Management, thinks Garp-style investment strategies can be significantly more complex than they appear; he urges two warnings. ‘The first is comparing a company in a brewing sector with a company in IT, for example,’ he explains. ‘Using a bald Garp comparison is pretty unsophisticated, and comparing apples with apples is pretty important.’
The other qualification, he says, is that some Garp approaches don’t differentiate sufficiently between the amounts of capital a company invests to achieve a certain level of growth. ‘You could have one company putting small amounts of capital to go into a particular industry, and another that puts a substantial amount of capital down,’ he points out. ‘Both could show the same Garp potential in a calculation. But it wouldn’t show that one company was doing it with substantially less capital than the other. Basing an investment purely on bald Garp numbers risks leading investors into some pretty tricky territory.’
Those same investors would also hope that company IROs, particularly on the matter of profits guidance, are briefing fund managers properly, says Pratt – but such guidance is often woefully poor. ‘IR departments should be guiding the City and analysts, broadly speaking, to what the profit figures will be,’ he notes. ‘Let’s say BT will shortly announce £10 bn ($16.9 bn) in profit. Its IR department should be guiding the City to those profit figures, so that when the announcement is made there are no surprises – the City really hates that. It wants to be guided accurately by an IR team.’
Pratt also expresses irritation that IROs are often highly selective on what areas they talk about, and with whom. ‘Clearly, IR people will talk more often to bigger shareholders but there still needs to be a level playing field,’ he says. ‘As a small shareholder I shouldn’t be treated any differently than a large investor, and would be upset if big investors were being briefed earlier with more information than I was getting.’
Being on time
Regular, timely briefings present few problems for Lay. ‘Generally we get what we want,’ he says. ‘The timeliness of data is always important, and accuracy from IROs, often when they are deputizing for a CEO or CFO, is mostly good.’
Reilly reports similarly good IRO feedback, though he says some black holes remain. ‘Most are good at producing timely accounts, which they’re legally bound to do, but where companies can be significantly weaker is addressing key issues that face their company on their own initiative,’ he notes. One of the biggest issues, he says, is getting companies to openly discuss their failings. ‘Some just can’t bring themselves to do this,’ he adds. ‘We are never looking for an admission of defeat, but we are looking for a means of understanding how a company deals with the various issues that face it. No company succeeds all the time in every activity but too often they keep things hidden until they’re fixed.’
Perhaps it’s not so surprising, but a lack of clarity or suspect fudging on issues is always discouraging for fund managers. And because lines of corporate business are often strewn over the entire globe, getting a real fix on a business can be somewhat hazardous. ‘Because we invest in large-cap companies it can be very difficult to get to know who, for example, is in charge of the capital expenditure program in Thailand or Latin America,’ complains Reilly.
He also says a few companies do organize annual centralized meetings where investors can sit down for half a day to meet those behind a company and hear their half of the story. But the logistical burden on IROs in organizing this – not to mention the many disclosure worries – would be considerable, he adds.
Earlier this year Morley Fund Management, a £100 bn ($169.5 bn) asset management company which has a decidedly Garp-style approach to its overall investment strategy, organized a series of business lunches across Europe and the UK. Doing its bit to broaden communication, it invited a mix of IROs along for a meal of stuffed chicken and smoked salmon.
The reason, says Sophie Blanpain, head of equity research at Morley, was a long-held recognition that both sides of the dinner table held prejudices against the other, and that talking directly – without any third-party broker presence – might help improve relations between the two camps.
The main conclusion both parties drew was how important it is to have direct contact between actual investors and the companies. ‘Partly, this is down to how we work with companies, and we expect openness,’ says Blanpain. ‘But we are in an industry that often makes decisions in quite opaque ways. If you’re an IRO and your main client is an analyst and you’re not sure what he or she wants, then getting the low-down isn’t easy.’
For Blanpain the classic, ‘red-tab’ original Garp investing strategy ultimately boils down to three components. ‘The first is a good return on invested capital,’ she explains. ‘If you put growth first you risk getting unprofitable growth. The second is straight growth in the business. And the third is the risk factors involved in the first two. Is this figure already assumed in the share price, or not? You have to compare your assumptions with what the market is expecting.’
The biggest hurdle against making a success of this central Garp reckoning, says Blanpain, rests on the overall risk factor. ‘That is why IRO clarity is so important,’ she says. ‘The more visibility we have, the better. If we’re confident about a position, then the greater the share price we will be willing to pay for it.’ Simple really.
