Sector Exposure And Turnover Limitations
“Two key differences between the two Sabrient indexes underlying those ETFs are the limitation on sector concentrations and turnover,” Brown said. “NFO enforces strict limits of 20% from any given business sector and 10% from any given subindustry. KNOW has no limits at all. KNOW can essentially take larger sector bets, whereas NFO ensures broad diversification.”
“In addition, NFO has a 25% turnover limitation on each quarterly rebalance to reduce transaction costs, while KNOW has no turnover limitation at all, and it rebalances monthly, which can lead to faster rotation in sector weightings,” he added.
Little Overlap In Portfolio Holdings
Portfolio construction is straightforward for NFO, and pretty active and complex for KNOW.
“The two underlying indexes both select from a range of capitalizations from small to large, and both employ the same basic underlying Insider/Analyst model to identify 100 stocks. However, there are significant differences in how we arrive at the final portfolios,” said Brown.
“For NFO, we start with a broad universe of over 4,000 eligible stocks that we track in our database, and the Insider/Analyst model is run to identify the 100 highest-ranked stocks, subject to the sector and turnover limitations. All 100 stocks are equally weighted. Overall, the process is pretty straightforward.
“On the other hand … KNOW’s selection process is more complex and active. For KNOW, we start by selecting only from the S&P 1500, but we eliminate the bottom 20% of stocks as ranked by our Earnings Quality Rank, leaving about 1,200 eligible stocks. We then run the Insider/Analyst model to identify the 100 highest-ranked stocks for the final portfolio—again, with no limits on sector concentrations or turnover.
“Next, we apply our Defensive Equity model to rank these 100 stocks according to their tendency to outperform during periods of market weakness, and each stock’s relative ranking is used to determine a modified exponential weighting.
“As a result, the KNOW portfolio seeks to provide a strong combination of earnings quality, insider buying, analyst upgrades and defensive investor sentiment,” he said.
Appeal To Different Types Of Investors
“KNOW is more complex, active, concentrated and unrestrictive in its search for the most compelling stocks for the coming month,” said Brown.
“Although some investors prefer such an aggressive approach, others prefer the process underlying NFO, as it is more conservative regarding turnover, transaction costs and diversification,” he added.
Why Own Either ETF?
To investors, these type of strategies are about enhancing potential returns by owning companies and sectors that show relatively strong insider sentiment, positive earnings outlook and are, therefore, more likely to outperform the market.
Long term, that has not only been the case, but, this year to-date, that has transpired, as both NFO and KNOW are outperforming the SPDR S&P 500 (SPY | A-99), as the chart below shows:
Charts courtesy of StockCharts.com
Contact Cinthia Murphy at [email protected].