Small mutual fund finds alpha in the boardroom

Those closest to the management of a company generally have the inside track on when to buy and when to sell the company’s stock — which is why an investment strategy based on insider activity makes so much sense.
David Miller, manager of the Catalyst Insider Buying Fund (INSAX), uses insider buying and sell as the driving force of his portfolio. The results are adding up even if assets in the fund are not.
The fund, launched in July 2011 by Catalyst Mutual Funds, has grown to less than $6 million despite delivering some rather respectable returns over that time. During the fund’s first full calendar year, it gained 17%, which compares to a 16% gain by the S&P 500 Index. So far this year, the fund is up more than 22%, while the S&P is up 17.2%.
Mr. Miller is co-founder and chief investment officer of Catalyst, a $300 million asset management firm. The specific insider-buying strategy is something he started focusing on while working on his MBA at the University of Michigan.
“There are lots of studies showing alpha coming from insider buying,” he said, citing one study that compared insider-buying activity to stock performance from 1975 through 1994.
In his own research, he looked at the buying activity of the highest-level executives of S&P 500 companies for the period from 2003 through 2010. He found that when at least three top-level executives collectively bought at least 10,000 shares of the company’s stock in a given quarter, that stock outperformed the S&P over the next 12 months by an average of 11.5%.
Conversely, if at least three top executives of a given company collectively sold more than 10,000 shares of the company’s stock during a quarter, the stock underperformed the S&P over the next 12 months by an average of 4%.
Mr. Miller’s fund does not sell stock short, but he explained, “If we start to see significant selling, we get out immediately, because 65% of the outperformance comes in the first six months.”
At least two exchange-traded funds employ similar strategies, but without the same focus on a handful of executives at the top of the companies. Guggenheim Insider Sentiment ETF (NFO) and Direxion All Cap Insider Sentiment ETF (KNOW) are both examples of strategies that also tap into insider activity, but they both track the more generic Sabrient Insider Sentiment Index.
The Sabrient index includes all insider activity, as well as analysts’ sentiment.
The $120 million Guggenheim ETF gained 14.8% last year and is up 19.4% so far this year. The $5 million Direxion ETF gained 15% last year and is up 17.8% so far this year.
Mr. Miller’s fund, which currently holds just 35 stocks, concentrates on U.S. companies with market capitalizations of at least $8 billion, providing a potential universe of about 350 stocks.
According to the latest report, the portfolio has a 21% weighting in both financial and consumer cyclical sector stocks, followed by 14% in energy, 11% in health care and 10% in industrial stocks. The largest holding, at 5%, is snack food marketer and manufacturer Mondelez International Inc. (MDLZ).
Beyond that, the fund has about 3.5% weightings in the following names: Gilead Sciences Inc. GILD), The Western Union Co. (WU), Bank of America Corp. (BAC), and General Motors Co. (GM).