In the KNOW: An Insider ETF

01/04/2016 9:00 am EST

Focus: ETFs

A relatively new exchange-traded fund is beating the market by owning stocks that high level company insiders, like the CEO and board of directors, are buying heavily, observes Tim Begany in Personal Finance.

The strategy makes sense. Nobody knows a company better than key insiders, who may sell their firm’s stock for various reasons but only buy if they think it’s going up.

In this category, the Direxion All Cap Insider Sentiment ETF (KNOW) is the clear winner. Since its December 2011 launch, the $136 million exchange-traded fund is up 89%, versus 65% for the S&P 500 (SPX).

That ETF's benchmark, the Sabrient Multi-Cap Insider/Analyst Quant-Weighted Index, consists of the highest-ranking 100 stocks and incorporates four measures of insider buying and company profit growth.

They include the amount of insider buying, the percentage increase in each purchaser’s holdings, the frequency of upward revisions in earnings forecasts and the percentage increase in those forecasts.

KNOW consists of 94% domestic stocks, so its sector allocations mainly reflect insider buying trends in the United States.

In recent years the fund benefited from hefty investments in healthcare and technology, two of the economy’s fastest-growing areas.

In a clear sign of insiders’ positive outlook, the fund invests most heavily in automotive, retail, and other consumer stocks, which usually excel when the economy is growing.

A healthy economy also favors the stocks of heavy-equipment manufacturers, railroads, and other industrial companies, which constitute 12% of fund assets.

A 17% position in the financial sector as insiders buy stocks that stand to benefit most from higher rates, like banks and insurance firms.

As rates rise, demand grows for interest-bearing savings and investment products and loans are more profitable. Insurers get better returns when they invest policy premiums.

KNOW’s allocation to energy stocks nearly tripled since April, to 11.5%, an indication that insiders strongly believe the energy sector will emerge from its protracted slump.
 
Though KNOW is fairly new, the fund has proven itself with a market-beating four-year track record. At 0.65% of assets, expenses are a bit high for an ETF but still well below what most mutual funds charge.

A caveat, though: To mimic its benchmark, KNOW has to buy and sell far more than most funds and has been replacing its portfolio holdings more than eight times a year, on average.

Such high turnover can produce large capital gains for shareholders, especially in rising markets, so the fund is best held in a tax-sheltered account, such as an IRA.

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