Alternative data is a red-hot topic in the investment community, driving a decision-making revolution. Alison Thomas explains what it is and why it matters
This article was first published in the October 2019 UK edition of Accounting and Business magazine.
Active investors are voracious consumers of data. The company reports, investor presentations and the like that they devour are essential reading for many. Yet information from those established sources simply isn’t enough for investors to outperform. For that, they need an edge that few others enjoy. And for many, that edge lies in ‘alternative data’.
Alternative data refers to data used by investors to gain insight into a company that comes from sources outside of that company. The concept is as old as the investment hills. Think back to the days of hedge fund managers employing minions to monitor shipments of cars across the US border. But its current incarnation is as different to the minion era as carrier pigeon is to email. It’s big business too, with AlternativeData.org estimating that the buy-side will spend over US$1bn on alternative data in 2019 – up from US$232m in 2016.
According to Demystifying Alternative Data by management consultancy Greenwich Associates, web-scraped data (ie data automatically gathered from websites) is the most popular type of alternative data. Capital markets consultancy Opimas estimates that web scraping for investment purposes accounts for a remarkable 5% of all web traffic – and it expects that figure to grow rapidly in coming years.
Use of this data is as varied as the web itself but includes analysing job listings to figure out who’s hiring and who’s not, monitoring online retail data (eg which products rate highly, which are heavily discounted, and so on) and evaluating airline bookings.
But web scraping is just the tip of the alternative data iceberg. If you want to know how much people are spending on food delivery, streaming services or gaming, you can buy app usage data. If retail revenue tracking is more your bag, then credit/debit card data or email receipts may be the answer.
Geolocation data allows the analysis of foot traffic, while automatic identification system tracking lets analysts forecast oil price movements or predict the next big corporate deal by tracking the movements of oil tankers and corporate jets respectively. Or consider the ability of satellites or drones to offer data as diverse as crop yields, oil and gas production, the status of construction projects or supply chains.
As these examples illustrate, the sources of alternative data are vast and growing by the day. But it’s not just new streams of data that define the age of alternative data; it’s also the availability of software that lets users turn data into insight.
Take natural language analytical tools. These transform investors’ ability to assess consumers’ sentiment towards products or companies. In Harnessing the data science revolution, Ben Wicks and Mark Ainsworth describe how Schroders used sentiment analysis to assess the ongoing impact of health scares at the US outlets of restaurant chain Chipotle. In similar vein, in early 2019, Mike Chen, dynamic equity director for asset manager PanAgora, reported it had expanded its exposure to China by launching a self-learning algorithm designed to decipher the sentiment behind Chinese cyberslang – an idiom used by retail investors to get around government censorship.
Does alternative data help investors to outperform? BlackRock CEO Larry Fink thinks so. In his letter to shareholders in the investment company’s 2018 annual report, he says portfolio managers are ‘integrating alternative data sources and data science techniques into their investment processes in order to generate more alpha’.
BlackRock is not alone. The Greenwich Associates’ study found that 71% of participants believe alternative data generates alpha, 30% of quant funds attribute at least 20% of their alpha to such data, and 42% think the resulting performance advantage lasts for at least four years.
Does the explosion in the use of alternative data sound the death knell for traditional forms of corporate reporting? Not according to Wicks, head of data insights and research innovation at Schroders. ‘The report and accounts will always remain the gold standard,’ he says. ‘There’s a wealth of data in it that only companies can credibly supply. Added to that, it’s audited.’
Nevertheless, this data revolution has consequences for all involved in corporate reporting. First, to communicate effectively with investors, it’s important to keep up to speed on the types of information they have at their fingertips, and the technologies used to process that data in real time.
Perhaps more importantly, businesses need to consider the balance of messaging in communications. Investors are quick to share stories of alternative data that highlights inconsistencies in management messages. Does weather really account for poor performance in a Brazil subsidiary? Do a company’s Glassdoor reviews support its assertion that employees are its number one asset? Does a product’s online reviews indicate the home run implied by management’s narrative report?
Those who cannot resist the urge to take a rosy view of performance may do well to stop and reflect: do investors see an alternative reality?
Alison Thomas is a consultant.
"Investors are quick to share stories of alternative data that highlights inconsistencies in management messages"