The Rise of Alternative Data Investing

The best investors keep ahead of the curve — but they don’t do so by luck or blind guessing. More often than not, a good investment comes down to quality data.

Investors and hedge fund managers have typically relied on data aggregated from quarterly earnings, SEC filings, or specific research reports to inform investment decisions, but as technology continues to proliferate — and collect — information, alternative data sets have emerged.

What is alternative data?

Alternative data is often defined as new, innovative, or non-traditional data used to gain a competitive edge in the market. Savvy investors are consulting everything from credit card and mobile app data to social media activity and weather patterns; The Atlantic even covered a pair of investors using satellite images of retail parking lots to make more precise sales predictions.

In a 2020 report on how hedge fund managers are using alternative data, the Alternative Investment Management Association (AIMA) (in conjunction with SS&C Technologies) further classified alternative data by its form, exposure, and use — “alternative data comes from unconventional information, mostly in an unstructured form, is not broadly distributed within the industry, and is being used to deliver both investment alpha and operational alpha.”

With this framework established, let’s take a closer look at the major types of alternative data, the implications of successful use, and the unique challenges posed by this cutting-edge resource.

Leveraging alternative data for investment decisions

But before we explore how alternative data works, let’s address why it’s so appealing to investors — aka the alpha of it all.

Alternative data for alpha investing

Alpha is a finance KPI used to measure an investor’s edge over the market. Investopedia defines alpha as the “excess returns earned on an investment above the benchmark return.”

In the scramble for investors to gain a market advantage, alternative data has emerged as a powerful tool to accrue alpha. In fact, AIMI reports close to 70% of market leaders are using alternative data as a powerful tool in their hunt for alpha.

Top alternative data sets

If you’re using alternative data to inform investment decisions and secure elusive alpha, it’s important to ensure you’re pursuing the right data sets. Many alternative data sets are industry-specific, but there are some overarching trends. After surveying top market leaders and representatives from the broader market, AIMA identified five of the most prevalent alternative data sets as:

• Web-crawled data
• Consumer spending
• Social media sentiment and online reviews
• Business performance metrics
• Data from expert networks

AIMA also found most respondents used two or more alternative data sets in their analysis.

Alternative data analysis

Once the alternative data has been compiled, analysis can inform several key components of the investing process. AIMI’s survey found market leaders and the broader market primarily used alternative data to augment these five functions:

• Finding new investment opportunities
• Improving investing decisions
• Quantitative research
• Generating outperformance
• Mitigating risk and improving compliance models

Thanks to these wide-ranging benefits, the impactful analysis of alternative data has understandably become a hot topic in the world of finance. TechTarget reports at the Ai4 2022 Finance Summit in March, alternative data was a frequent subject of discussion among leading AI vendors and finance firms.

Challenges of using alternative data

But for alternative data to be used successfully, a number of challenges must first be overcome.

All data has to be aggregated before it can be analyzed, but due to the inherent disorganization of new data sets, this often requires unique algorithms, large volumes of cloud storage, and strong computer processing power. Consequently, 54% of market leaders surveyed by AIMI described “appropriate infrastructure” as a barrier to using alternative data. Luckily, companies like BattleFin have emerged to meet the need for powerful aggregators, enabling investors to successfully use alternative data sets in their research and reports.

Another common concern for investors considering alternative data is the return on investment (ROI). AIMI found 72% of market leaders considered alternative data “very important or important to enhancing their overall value proposition” — but 27% also cited “demonstrating ROI” as a challenge.

Due to the novelty of alternative data, there is also widespread concern over its governance. 20% of market leaders surveyed in the AIMI report cited regulatory and compliance issues — like data consent, private information, and IP rights — as a significant challenge associated with using alternative data. But, as AIMI is clear to point out, the issue is not a lack of governance around “data in general” but the lack of “a commonly agreed framework which specifically touches on alternative data.” AIMI concludes, “We are now witnessing an emergence of important legal and regulatory jurisprudence that is likely to start filling in the gaps in understanding of how existing laws apply to the purchase and use of the data.”

These challenges likely explain why alternative data has not seen more widespread adoption. Institutional Investor reports that a 2020 survey conducted by Bank of America found 55% of the $434 billion managed by those surveyed was invested without analyzing alternative data sets. Of those respondents who were using alternative data at the time of the Bank of America survey, 59% had been doing so for only two years or less.

Preparing for the future of alternative data

By 2025, it’s predicted people will generate 463 exabytes of data each day. With this staggering amount of data on the horizon, alternative data analysis is primed to become more prevalent than ever. AIMI’s survey of hedge fund managers certainly backs this up; 61% of market leaders expect alternative data will experience more widespread adoption by 2025.

To prepare for a future powered by alternative data, investors should start forming a strategy now. Finding solutions to the challenges posed by aggregating new data sets, justifying ROI, and adhering to regulatory requirements should be an essential part of any alternative data management plan — but investors don’t need to go it alone. New tools and resources are emerging to address the rise of alternative data and ensure financial firms can successfully use cutting-edge data sets to power market research, generate reports, and accrue alpha.

The DAM approach to alternative data

Eidosmedia’s platforms are equipped with advanced digital asset management (DAM) tools needed to onboard and manage all kinds of unstructured data, making it accessible in real time across the research operation.

To learn more about how Eidosmedia meets the needs of investment research firms, check out these case studies on our work with global investment banks, asset management companies, and rating agencies.