In a previous blog, we took the first and second steps in our Growth at a Reasonable Price (GARP) strategy construction. We introduced the GARP investment strategy and showed how it can be implemented systematically. In this blog, we will take the third and fourth steps: using a multi-factor sequential filtering process for security selection and establishing constituent weights.
Multi-Factor Sequential Filtering Process
There are a number of approaches one can take to construct multi-factor portfolios—mainly integration, sequential filtering, and optimization. We use the sequential filtering method because it is easy to understand and effective in achieving its targeted factor exposures.
Multi-factor sequential filtering selects stocks using two layers of filters, as shown in Exhibit 1. In the first step (filter 1), stocks are ranked by their growth z-scores, with the top 150 stocks remaining eligible for constituent inclusion. In the second step (filter 2), those 150 stocks are then ranked by their quality & value (QV) composite z-scores. The top 75 stocks are selected to be included in the strategy after applying a 20% buffer rule. The 20% buffer is applied to reduce portfolio turnover.
Once constituents are selected at each rebalance, eligible securities are weighted by their growth score to achieve the strategy’s growth exposure. To limit the impact of extreme values, the maximum weight of a security is capped at 5%. Individual GICS® sector exposure is capped at 40% to broaden the strategy’s sector exposure.
In this and a previous blog, we discussed our GARP strategy construction process. In coming blogs, we will present the empirical results of the strategy performance, its sector composition, and its performance attribution.
 S&P Quality, Value & Momentum Multi-Factor Indices Methodology, February 2019.
 Buffer Rule: A 20% buffer is implemented as follows:
- Stocks in the top 150, based on growth z-score, are ranked by their QV composite z-score. The top 60 stocks are automatically chosen for index inclusion.
- Stocks that are current constituents that fall within the top 90 based on their QV composite z-score are chosen for index inclusion in order of their QV composite z-score.
- If at this point 75 stocks have not been selected, the remaining stocks are chosen based on their QV composite z-score until the target count is reached.