As hedge funds and asset managers seek to boost returns and explain their strategies to clients, they are increasingly turning to alternative data sources. Investors are spending nearly $183 million annually on such data alone, according to a Greenwich Associates study. Tabb Group estimates the industry could more than double in size in the next five years, while a JPMorgan study shows that all in the buy side could be spending from $2 to $3 billion annually when hardware and analytic costs are considered. Despite the high costs, those purchasing the data are overwhelmingly satisfied, with a Quinlan & Associates study noting a meaningful increase in profit margins of up to 35% those firms using alternative data sources.
BlackRock likes sensor technology as an alternative data filter
Technology can provide new information and investing insight, but it can also contribute to making information ubiquitous and stale.
BlackRock’s Larry Fink recognizes the double-edged sword. Their firm uses alternative data in their investment processes but is primarily focused on data mined recently.
“We’re using technology to use information that has been created in the last three to five years,” he said in a recent interview, pointing to new methods of information collection such as sensor technology.
Information that at one point was the baseline upon which investment decisions were made, such as balance sheets and income statements, are now commonplace. “There’s nothing special to having that information any longer,” he said, pointing to an obsolescence once mass distribution of information has occurred.
It is this search for new insight that is not widely recognized or distributed that is driving alternative data usage. And it is currently working.
“Today’s alternative data sources will only be alternative for so long”
Alternative data is mined through a variety of processes. This includes satellite imagery used to identify traffic patterns and infer economic activity to cell phone geolocation data aggregation to scanning of emails to pry open consumer sentiment. Monitoring social media sentiment can occur after a much-anticipated product launch another example, with the recent Apple iPhone launch the most recent example. But there are also lesser known examples, which adds value to the information. With new artificial intelligence sensors starting to read images and even facial expressions to gain insight, new sources of alternative data could expand the market.
Greenwich study found that the top uses for alternative data sources were to find investment opportunities, research investment decisions and “feed algos” so they can trade on predefined signals. Nearly 75% of the hedge funds surveyed use social media news feed analysis, while logistics data and satellite imagery were also high on the usage list.
Whatever the data collection methodology and usage, buy side investors like it. The Greenwich study indicates that 90% say they have seen the return they hoped for, with 95% of hedge funds saying using alternative data helps them explain their strategy better. Many plan on increasing spending in the area, with 74% of hedge fund respondents expecting to boost their commitment to alternative data.
The biggest roadblocks to alternative are adoption from senior management and the high price tag. Among hedge funds, 42% said “prohibitively high fees” are causing consternation, with 37% saying that “management not convinced of the data’s value” is holding back adoption.
“Convincing management that a data set will, in fact, generate the returns needed to justify the costs is no small feat,” Greenwich Associates authors Dan Connell and Kevin McPartland wrote in the report.
To keep much of the data exclusive and more useful, many fund managers are demanding exclusivity or limited usage clauses in their contracts. This, the Financial Times noted, could put fund managers in legal jeopardy. Jonathan Streeter, a former federal prosecutor who led the insider trading case against Raj Rajaratnam, noted an expectation that prosecutors might bring a case against a hedge fund that employs alternative data that is nonpublic in nature. “It’s a brave new world,” he said.
There are two issues with developing a unique investing strategy. One is finding a new method and the second is keeping it secret.
“Investors hoping to replicate that advantage better move fast, because the term ‘alternative’ is fleeting,” McPartland noted. “Today’s alternative data sources will only be alternative for so long.”