SmartGARP®

The investment process was developed by Philip Wolstencroft during his time working as an equity strategist at Merrill Lynch. He developed it in an attempt to distil what all active fund managers do, but in a more systematic way and to remove the behavioural biases he often observed from fund managers in his role as a strategist. It was based on the belief that inefficiencies exist in global stock markets because investors do not always act rationally. SmartGARP seeks to address this by using data to be more objective, rigorous and systematic in the analysis of companies’ financial characteristics and in decision-making.

The first fund to use the process was the Artemis SmartGARP European Equity Fund, launched when Philip joined Artemis in 2001. The process has been developed and refined ever since.

From a universe of approximately 6,000 global companies – with minimum levels for market cap (US$500mn), liquidity and analyst coverage applied – SmartGARP aims to identify companies that are growing faster than the market but are trading on lower valuations than the market. They should be enjoying strong and consistent upgrades to profit forecasts and be under-owned by the investment community, while at the same time benefiting from helpful macroeconomic trends. In other words, ‘growth at a reasonable price’ (GARP).

We believe that share prices ultimately follow fundamentals. To illustrate this, we look at ‘value per share’ (VPS) as an aggregate measure of a stock’s fundamentals. VPS is a combined measure of earnings, cash flow, operating profits, dividends and asset value per share. Divergences between the share price and the VPS can signal an opportunity or a risk.

In the long-term, we believe the two are highly correlated and held together by an elastic band. Divergences can occur between the two, but usually these will snap back and correct. At times, share prices can overshoot the performance of the business. This is often down to over-optimism about future growth prospects or a lack of account for risks to growth.

The SmartGARP tool uses eight different measures to analyse stocks within a given universe:

Top-down factors

Macro
Investor sentiment and ownership

Bottom-up factors

Growth and Value
Estimate revisions
Momentum
ESG factors
Accruals

See above for more detailed explanations of each one. 

Each factor is given equal weighting apart from ‘estimate revisions’ which is double weighted. This is because the team view earnings upgrades as the strongest and most reliable indicator of an improving share price.

The value factor varies between being half weighted and double weighted to reflect the dispersion of valuations and the recent performance of value investing.

There are over 6,000 stocks in the investible universe. We rank every company on eight factors and, then rank them against the universe to give them an overall ‘SmartGARP score’ out of 100. Companies with a score above 80 are considered for inclusion in the fund. The fund managers then carry out due diligence on these stocks. This is to identify non-operational issues (such as accounting changes, acquisitions or disposals etc.) that may be skewing the data. The fund manager then builds a diversified portfolio according to the stock and sector limits of the strategy.

No. SmartGARP is an evidence-based approach to investing, incorporating well understood and accepted investment principles, but deployed in a systematic fashion. It mimics how most fundamental investors would think about things but avoids many of the biases that traditional managers can suffer from.

In client meetings, we regularly demo the tool to provide transparency and help explain how the fund managers interact with the system to make decisions.

We consider the process to be 80% systematic, 20% fund manager overlay. After running the screening tool, the fund managers carry out due diligence on the stocks that score highly. This is to identify non-operational issues (such as accounting changes, acquisitions or disposals etc.) that may be skewing the data.

This is strictly a validation exercise to ensure that the financial data is a complete and accurate reflection of the underlying characteristics of a company. The fund manager is not looking to gain detailed insights of the company’s business or meet its management which might compromise the investment process by introducing subjectivity and behavioural bias.

The other element driven by the managers is the timing of investment decisions.

At times of severe market distress, such as the start of the Covid pandemic, the fund manager overlay plays a bigger role.

The screening tool is run daily.

The fund manager monitors the SmartGARP score, watching for persistent degradation. Typically, as the score fades towards 50 the manager will be trimming and reallocating to higher scoring companies. As the score falls below 50, that is typically a signal to sell the position. Trading activity is elevated around earnings season given this is when newsflow around a company’s fundamentals is at its highest.

SmartGARP works in most market conditions apart from times of extreme stress, such as the Global Financial Crisis or Covid. The volatility skews data in the short term, as the tool normally focuses on identifying long-term patterns. At this point the human element of the process plays a bigger role.

Five Artemis funds use the SmartGARP process: Global, Global Smaller Companies, European, UK and Global Emerging Markets.

SmartGARP works in any market, as is evidenced by the global fund, which invests in all regions. The tool works particularly well in under-researched areas, such as emerging markets and medium-sized companies (‘mid caps’) across all markets.

Over recent years it has worked less well in the US which has a great deal of analyst coverage and has recently been a highly concentrated market.

The tool has developed slowly and in a considered fashion to include new data and new data-capture techniques available.

The most recent substantive change was when the ESG factor was added in 2018. Other changes have been more incremental. The team constantly tests sources of data, but the core of the process remains largely unchanged.

The team’s dedicated quantitative IT developer focuses on data architecture design and facilitates in the testing of new and existing datasets.

SmartGARP’s style bias has shifted through time. It is currently biased towards value, because that is where it is seeing opportunities. However, given the process incorporates a range of factors, you should also expect to see within the holdings, positive revisions, as well as good growth and quality characteristics.

We do not have hard limits on factor tilts. But we monitor them and style tilts (e.g. towards growth, value, revisions, top down etc) which should not be negative for any significant length of time.

On a quarterly basis we have formal risk reviews with our independent Investment Risk Team. In these meetings, we cover a range of topics around portfolio positioning, trading decisions, attribution, and outlook.

Given the nature of the tool, the funds have a high active share and look different to the peer group. This is because the tool casts the net wider than even a large team of analysts could, uncovering opportunities that others may miss.

The tool screens the universe to direct the managers towards the best ideas. This means a large team of analysts is not necessary.

The tool is a powerful and efficient method of screening a large universe of stocks and focusing the fund managers attention on the best ideas according to SmartGARP. Time is not spent conducting deep fundamental research, meeting management, or managing a large pool of analysts.

In addition, a small team has its advantages; short lines of communication, quick decision making, and ownership of the outcome engenders positive outcomes.