Investment strategies tend to come and go quite quickly, but one that has held up relatively well over time is insider transaction monitoring.
Given that company insiders tend to have the most up-to-date information on their companies' future prospects, the theory is that insider transactions can help predict future stock returns.
Does an insider transaction strategy offer genuine outperformance potential though?
That’s what analysts at MSCI recently set out to determine, using insider transaction data provided by 2iQ Research.
Here’s a concise look at their study and its findings.
Insider transaction analysis
In order to evaluate the potential explanatory power of insider transactions on future stock returns, Vipul Jain, Vice President, Equity Factor Research and Roman Kouzmenko, Executive Director, MSCI Core Equity Research back-tested 2iQ insider-transaction data dating from June 2006 to April 2019.
The dataset included information on over 12,000 companies across 50 countries, with approximately 4,150 of these companies in the MSCI All Country World Index (ACWI) Investable Market Index (IMI), and 1,850 companies in the MSCI USA IMI.
Notable country exceptions were Japan – due to the lack of regulations in relation to the reporting of corporate insider transactions in the country – as well as Taiwan, Saudi Arabia, Mexico, Argentina, Colombia, Qatar and the United Arab Emirates.
To study the link between stock returns and insider transactions, Jain and Kouzmenko analysed the data from count, volume, and depth perspectives.
Figure 1. Insider sentiment metrics
Then, using an equal-weighted combination of the count, volume, and depth of insider-trade metrics, they constructed an ‘insider-sentiment factor’ and tested this factor in both univariate and multivariate settings.
Note that two different formulations of the insider-sentiment factor were analysed:
● All transactions – this was based on all insider transactions
● Filtered transactions – this was based on transactions by top-level executives such as board chair, executive board, supervisory board, executive committee, board of directors and senior nonexecutives, and excluded transactions linked to employee compensation plans, automated investments from 10b5-1 plans and trades executed for tax purposes
Below are the findings of the study.
Figure 2. Performance characteristics of insider-sentiment factors
Figure 3. Insider-sentiment factor returns
Figure 2 and Figure 3 show that both formulations of the insider-sentiment factor generated consistent, positive factor returns throughout the analysis period along with positive quintile spread returns and information ratios. In other words, following insider money could help generate strong investment returns.
Meanwhile, Figure 4 below shows that the insider-sentiment factors had low correlations with traditional style factors such as size, liquidity and analyst sentiment.
Figure 4. Correlations of insider-sentiment factor with other factors
Overall, the MSCI analysts concluded that insider transaction data could be a potential avenue to construct factors that generate positive risk-adjusted returns after accounting for traditional factors.