How Alternative Data Is Changing Finance

With apologies to Fiddler on the Roof’s Tevye, the traditional ways can only deliver so much.

That’s essentially the impulse that, for the last several years, has driven hedge funds and other investment firms to augment conventional data sources like SEC filings and quarterly financial statements with newer, sometimes wildly outside-the-box data. Those streams now include everything from credit card transaction data and web-scraped social media to satellite imagery and IoT sensors. In the scramble for alpha — the financial industry’s term for market advantage — no data set is too obscure as long as some actionable signal can be gleaned.

WHAT IS ALTERNATIVE DATA?

Alternative data refers to non-traditional data sets that investors use to guide investment strategy. Examples of alternative data sets include credit card transaction data, mobile device data, IoT sensor data, satellite imagery, social media sentiment, product reviews, weather data, web traffic, app usage and ESG (environmental, social and corporate governance) data. Some alternative data providers also track corporate jet flights, government contracts and Congressional trading.

The figures tell the story of alt data’s fast rise. The number of alternative-data providers is more than 20 times larger now than it was 30 years ago — with more than 400 currently active providers, compared to only 20 in 1990, according to a report by the Alternative Investment Management Association in collaboration with fintech company SS&C.

Today, roughly half of all investment firms use alternative data, according to both the AIMA report and another recent survey by Bank of America. And that number will likely continue to grow, as more firms have invested in new technology during the pandemic. A recent survey by AIMA, in conjunction with Simmons & Simmons and Seward & Kissel, found that 34 percent of hedge fund managers surveyed said their firms are newly investing in alternative data.

What Is Alternative Data?

Alternative data is data culled from non-traditional sources and used by investment firms to find a market edge. Providers are constantly looking for new, untapped streams of data, so a category list is fluid by nature. For instance, newcomer sites that track trading disclosures made by members of Congress (and the viral TikTok accounts that amplify them) are essentially alternative data — not dissimilar in idea from the government contract data that’s considered an established part of the alt-data landscape. 

That said, some categories are more established than others. Here are a few must-know types of alternative data.

WEB TRAFFIC AND APP USAGE

Is a software company’s application attracting new users or dropping them? Are sites in a particular product category suddenly seeing an influx of visitors? The answers to these kinds of traffic-data questions are manifestly valuable to traders, so it’s no surprise that web and app analytics services have become de rigueur tools in the alternative-data toolbox.

A noteworthy player here is SimilarWeb. The service’s sophisticated data sets, available through a user-interface platform or direct API, encompass some 100 million sites and nearly five million apps, with coverage stretching back to 2015, according to the company. (The further coverage goes back, the more valuable the data set.) In May, it became the first alternative-data company to go public, seeking to expand its client focus beyond the hedge funds that first took notice.

SOCIAL SENTIMENT AND PRODUCT REVIEWS

Just as marketers use social listening tools to monitor brand perception online, investment firms consider social media data when evaluating stocks. Alt-data provider Thinknum, for example, has a Facebook Followers collection, which tracks “like” numbers, check-in counts and other Facebook information for more than 130,000 companies, dating back more than six years. It has similar data sets for other social networks.

Product reviews can also help firms decide whether to buy, sell or hold. Thinknum’s media outlet, the Business of Business, noted earlier this year that, before Peloton shares tumbled nearly 15 percent in the wake of a treadmill recall, the number of online reviews that included “terrible,” “awful,” “poor,” “bad” or “broken” had gone up from three, in 2019, to 31 — a signal to sell for those who were tuned in and so inclined.

SATELLITE IMAGERY

Satellite imagery proved to be an effective financial analysis tool as early as 2009. That’s when, according to The Atlantic, then-startup RS Metrics used three years’ worth of satellite data to validate Walmart founder Sam Walton’s long-held belief that the number of cars in stores’ parking lots correlated to overall revenue. E-commerce complicated that a bit, of course, but imagery providers continue to find uses that financial firms consider lucrative, including monitoring deforestation or natural disasters that may impact supply chains. Expect the trend to continue, as companies like SpaceX and OneWeb have prompted a massive surge in satellite launches.

GEOLOCATION

Where people go is valuable information. More specifically, the GPS data their phones ping across cellular networks, revealing broader consumer movement trends, is valuable info. That became even more true during the pandemic: Geolocation data provider SafeGraph saw near-record earnings and a spike in interest from financial institutions last year, according to Insider. In the past, geolocation hasn’t been considered quite as beneficial as other sensor-based alt-data streams, like satellite imagery. But when formerly predictable traffic patterns are disrupted, Wall Street’s appetite for GPS seems to expand.

JET TRACKING

When a private jet carrying representatives from oil producer Occidental landed in Omaha, Nebraska in April 2019, to meet Warren Buffett, news of the arrival extended beyond the Berkshire Hathaway chairman and CEO. The alternative data company Quandl, which tracks private jet flights, shared news of the visit to its hedge fund clients, who reportedly pay upwards of $100,000 per year for such intel. The cost paid off days later, when Buffett announced a $10 billion investment in Occidental, sending its value skyward.

In the years since, “corporate aviation intelligence,” as Quandl calls it, has grown more widespread. Quiver Quantitative, a free alt-data platform, launched in 2020, that aims to give everyday investors a Wall Street-style advantage, now offers a corporate private jet tracker to all.

Making Alternative Data Useful

One of the precipitating factors behind the rise of alternative data was the “quant quake” of 2007, Yin Luo, vice chairman of quantitative research at data firm Wolfe Research, told MarketWatch. Quantitative hedge funds (“quants”) had herded around the same stocks, then moved to sell all at the same time, resulting in heavy losses. New data sources promised unique advantages and a way to break the pack mentality.

A year after the quake, now-shuttered MarketPsy Long-Short Fund began incorporating social-media sentiment into its models. A few years later, a leading London hedge fund kickstarter investments based on a 2010 study that showed a probable relationship between Twitter mood and the Dow Jones index, Deloitte reported. Alt-data vendors proliferated in the years to follow and fundamental hedge funds soon began to follow the path paved by the quants.

The industry has blossomed, but access doesn’t inherently mean advantage.

Culled from builtin.com by Stephen Gossett

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