Under The Hood: Legal Insider Trading

Published on Friday, 30 December 2011 11:13 Written by ETF Professor

The term "insider trading" usually conjures up negative vibes, but there is a legal version of it - and some investors just love following insider transactions at various companies to glean clues about the future direction of the stock.

If that's you, Direxion has two new ETFs that might pique your interest. Those ETFs are the Direxion All Cap Insider Sentiment Shares (NYSE: KNOW) and the Direxion Large-Cap Insider Sentiment Shares ETF (NYSE: INSD).

Both funds set sail earlier this month, marking Direxion's second foray into the unleveraged universe. A previous attempt with an unleveraged airline ETF was, well, grounded to say the least. In this week's edition of "Under The Hood", we'll get to "KNOW" the Direxion All Cap Insider Sentiment Shares, which tracks the Sabrient Multi-Cap Insider/Analyst Quant-Weighted Index.

With an expense ratio of 0.65%, KNOW's quantitatively-weighted index includes the top 100 companies from the S&P 1500 Index.

That leads to an almost 24% allocation to energy names, nearly 19.6% to financials and over 14.5% to technology and consumer discretionary stocks.

No stock gets a weight greater than 2.6% and the top-10 roster is chock full of familiar names including Lincoln National (NYSE: LNC), MetLife (NYSE: MET), HollyFrontier (NYSE: HFC), Valero (NYSE: VLO), Smithfield Foods (NYSE: SFD) and Hess (NYSE: HES).

So what exactly is KNOW supposed to do? According to its fact sheet, the index the ETF tracks "reflects positive sentiment among those “insiders” closest to a company's financials and business prospects, such as top management, directors, large institutional holders, and the Wall Street research analysts who follow the company."

Said differently, this is arguably a niche ETF that is designed to help investors follow the smart money. You know, companies that are seeing insider buying by executives, institutional buying and those companies that are on the receiving end of favorable analyst comments.

Is there utility in an ETF that's designed to track insider sentiment? The answer is yes. While that may surprise some critics of niche ETFs, it must be said that the Guggenheim Insider Sentiment ETF (NYSE: NFO) has been around for more than five years and has amassed over $96 million in assets under management in that time. Someone must like the idea of buying stocks that are prized insiders.

To be sure, there are differences between KNOW and NFO, but the rivalry appears to be a natural one. For now, with KNOW being less than a month old, we're not going to pass judgment. Just know that if you want to be an insider without getting in trouble, KNOW is one ETF that can help with that. It should be noted that most executives only buy their company's stock for one reason: because they think it's going up. Maybe that alone will validate KNOW as a solid new niche ETF.