This fund beats the S&P 500 using only 75 of its constituents. Here’s how it works.

Let’s start with a 10-year chart comparing total returns to dividends reinvested for the Invesco S&P 500 GARP ETF SPGP,
+0.69%
and the SPDR S&P 500 ETF Trust SPY,
+0.71%,
which tracks the S&P 500 benchmark:

So far this year, SPGP is down 12%, while SPY is down 16%. But the long-term chart shows significant and consistent outperformance for SPGP, even during the bull market.

The S&P 500 GARP Index

GARP stands for “growth at a reasonable price”. SPGP tracks the S&P 500 GARP Index, which is replenished and rebalanced twice a year, on the third Friday of June and December. The next change will take place on December 16.

The S&P Dow Jones Indices assign a growth score to each component of the S&P 500 by averaging the three-year compound annual growth rate (CAGR) for earnings and sales per share.

The top 150 constituents of the S&P 500 by growth score can be included in the GARP index. These 150 are ranked by “composite quality/value score”, which is the average of these three ratios:

• Financial leverage — total debt to book value.

• Return on equity — trailing 12-month earnings per share divided by book value per share.

• Earnings to Price — 12 months of earnings per share divided by share price.

The top 75 of 150 QV rankings are then included in the GARP index and weighted by the growth score, with portfolio weightings ranging from 0.5% to 5%.

There is a 40% weight limit for any one of the 11 S&P sectors.

Dealing with concentration risk

The benchmark S&P 500 Index SPX,
+0.68%
is market-cap weighted, which means it’s more heavily concentrated than you might think – success is rewarded, with rising stocks being more heavily weighted over time.

This can backfire on you during a bear market, with Amazon.com Inc. AMZN,
+1.49%
down 47% and Tesla Inc. TSLA,
-0.84%
down 51% this year, to name just two notable examples.

Looking at the SPDR S&P 500 ETF Trust SPY,
+0.71%,
which is the first and largest listed index fund and tracks the benchmark by owning all of its constituents, six companies (Apple Inc. AAPL,
+1.04%,
Microsoft Corp. MSFT,
+1.30%,
Amazon, both classes of common stock of Alphabet Inc. GOOGL,
-0.48%

GOOG,
-0.38%
and Berkshire Hathaway Inc. BRK.B,
+0.13%
) represent 19.2% of the portfolio.

That percentage has fallen this year, but much of the risk remains concentrated in a handful of companies. (Apple alone accounts for 6.4% of the SPY portfolio. Tesla is now the ninth-largest holding, accounting for 1.4% of the portfolio.)

One way to approach high concentration in an index fund is to use an equal weight approach, which Mark Hulbert recently discussed.

For the Invesco S&P 500 GARP ETF, the underlying index selection methodology resulted in much less portfolio concentration than observed in SPY, with the top five holdings accounting for 10.9% of the portfolio.

Here are the 10 biggest participations of SPGP:

Company	Teleprinter	Share of portfolio
Regeneron Pharmaceuticals, Inc.	RAIN, +1.11%	2.49%
Cigna Corporation	THIS, +0.60%	2.26%
Everest Re Group, Ltd.	RE, +0.73%	2.21%
Vertex Pharmaceuticals Incorporated	VRTX, +1.40%	1.98%
DR Horton, Inc.	DHI, +0.23%	1.97%
Expeditors International of Washington, Inc.	EXPD, +0.54%	1.96%
Incyte Corporation	INCY, +0.10%	1.92%
Goldman Sachs Group, Inc.	GS, -0.56%	1.83%
eBay Inc.	eBay, +1.34%	1.81%
Pfizer Inc.	EFP, +2.20%	1.73%
Source: FactSet

Click on the tickers for more information about a company, ETF or index in this article.

You should also read Tomi Kilgore’s in-depth guide to the Wealth of Free Information on the MarketWatch quotes page.

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