The Insider Effect:
How Insider Trading Forecasts Returns

Daniel Drew,  12/5/2014


Gordon Gekko

   

Nothing can match the thrill of insider trading.

In 1998, Nejat Seyhun wrote Investment Intelligence from Insider Trading. He found that stocks with insider buying outperformed the market by 8.9% over the next 12 months. In contrast, stocks with insider selling underperformed the market by 5.4%. "Insider" referred to executives at the firm.

Someone at Guggenheim Investments got the message and started the Guggenheim Insider Sentiment ETF on September 21, 2006. Since then, the ETF has gained 101% while the S&P 500 has gained 58%. This is an outperformance of 43%, or about 5.4% per year.



Guggenheim Insider Sentiment ETF

Source: Yahoo Finance



The ETF is based on the Sabrient Insider Sentiment Index . The index has about 100 companies in it and uses a quantitative method of selection. Rebalancing takes place every quarter. The objective of the index is to actively represent a group of securities that are reflecting favorable corporate insider buying trends (determined via SEC filings) and Wall Street analyst earnings estimate increases.

This ETF is not a magic solution. It is exposed to the normal risks of the stock market in general and suffered the same catastrophic losses in the 2008 crash as the S&P 500. However, the insider effect remained a viable force and led to significant outperformance since then.

The Insider Sentiment ETF focuses on insider trades at individual companies. How about tracking all of the insider trading in the market? While executives used the shareholders' money to buy back $275 billion of stock during the first half of 2014, they were net sellers of their companies' stock. The ratio of buys to sells is near the lowest since 2000. In case you don't recall what happened around 2000, here is a visual reminder:



2000 Crash

Source: Google Finance