Weiskopf: Can you speak about the other factors that make up your process in the indexes underlying KNOW and NFO? I don’t see a lot of overlap in the holdings. How does the screening process work beyond the insider buying?
Brown: 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.
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, Direxion’s KNOW selection process is more complex and active. It essentially combines aspects of both Insider Sentiment NFO and Defensive Equity DEF.
Our Defensive Equity Index employs a proprietary model that ranks how well a given stock holds up on particularly weak market days, i.e., an investor sentiment metric that also translates into relatively low volatility, as well as our Earnings Quality Rank (EQR), which is a model we developed with Sabrient subsidiary Gradient Analytics to measure the relative aggressiveness of a company’s accounting practices.
For KNOW, we start by selecting only from the S&P 1500, but we eliminate the bottom 20 percent of stocks as ranked by our EQR, 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.
As you can see, KNOW is more complex, active, concentrated and unrestrictive in its search for the most compelling stocks for the coming month. 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.
Dan Weiskopf: David, thank you for the time and the explanation of how sentiment can be used as an investment factor.
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Dan Weiskopf is a portfolio manager at Access ETF Solutions LLC, whose third-party ETF strategies are offered through IPI Wealth Management, Inc. (IPI). IPI is an SEC-registered investment advisor, with its principal office located at 226 W. Eldorado St., Decatur, IL 62522, 217-425-6340. Access ETF Solutions LLC is not affiliated with IPI. Readers are advised to read the full transcript of the interview, including disclosures at http://accessetfsolutions.com, or to contact Dan Weiskopf at 212 628-4882. At the time of the intgerview, the manager may directly or indirectly hold a position in the Direxion Insider Sentiment ETF (KNOW) ETF. This interview should be viewed as an educational piece and not a recommendation.