Alternative Data: Your Edge to Finding Alpha?

Buy-side firms have unprecedented access to data, and powerful tools to analyze that data. This is a good thing. However, if everyone has access to the same data and similar tools to analyze it, the quest for alpha becomes harder than ever. So institutional investors are looking for new data sets from which to extract alpha. We present to you… Alternative Data.
​

Alpha is the needle in the haystack, but now everyone is on the haystack with awesome pitchforks

​By no means would DIH every say finding alpha has every been easy, but consider the current world of capital markets…

Everyone has access now to market information. Real-time market data feeds no longer require a lot of expensive hardware and bandwidth to receive. Company financials and fundamental data is readily available to the public. Whether you’re quantitative or discretionary in your approach, everyone basically has the same (traditional) data at their fingertips. We’re all in the same haystack.

Plus, the tools to analyze this readily available data have greatly improved in recent years. The cost for those tools has also dramatically reduced (thank you, open source!). So now we all have new, shiny pitchforks.

What about brains? Aren’t some of us smarter than our peers, and therefore have an advantage when looking for alpha? Just like we feel about our children, we want to believe our quants, portfolio managers and traders are the smartest of all. However, let’s face it — all institutional investors only hire the smartest people they can. The days of getting a job on Wall Street because you were in the same fraternity in university as a partner in the firm are long gone. You must have the grey brain matter to do the intellectually demanding work. So the likelihood that your firm is dramatically “smarter” than your competitors may a bit of stretch.  Sorry, but it’s true.

In this new leveled playing field, many firms are looking for an edge by adopting Alternative Data.
​

What exactly is “alternative data” anyway?

There are a lot of definitions floating around, but at DIH we like to define alternative data (a.k.a. “alt data”) as coming from a nontraditional source, often outside the capital markets community. Such alt data can yield new insights that complement more traditional data.

Some examples of alt data are:

• Crowdsourced research
• Social media
• Logistics
• Satellite imagery
• Geolocation data
• Private company data
• Online shopping data
• Evaluated prices (e.g.bonds)
• Historical credit score data
• Healthcare / clinical trials data

​

---

How the buy-side uses alt data

If you’re not yet analyzing alt data, here are some examples of how your buy-side peers are utilizing alt data:

Satellite Imagery — When evaluating a publicly traded retailer, you might look at pictures of shopping mall parking lots over time. Combine this imagery data with foot traffic data and more traditional retail sales figures.

Private Company Data — If a tech stock has announced the release of a new product, you could look at its supply chain, made up of various components coming from small, privately held suppliers all over the world. Are any of those suppliers under financial stress (e.g. increase over time of their accounts payable, recent court filings, downgraded credit ratings, etc.) that may adversely impact the timely delivery of the tech stock’s new product? 

Online Shopping Data — If a consumer electronics company has releases a new version of one of it’s popular products, you could detect an issue with the product’s quality from the ratings given by online shoppers BEFORE the company releases its quarterly financials.

Healthcare Data — If you track the pharmaceutical and biotech industries, imagine the insights you could gleam by having a holistic view of drug research, manufacturing and distribution. You could trace drug development from clinical trial to patent expiration, or explore reports of adverse drug effects.​

The challenges slowing Alternative Data adoption

Based on a survey conducted by Greenwich & Associates in late 2016 of buy-side firms, 80% want to access more alt data. So why hasn’t alt data not become more mainstream? Raise your hand if any of these challenges sound familiar…

1. COST — Many buy-side firms continue to operate in an environment of trying to reign in data costs, and therefore experience sticker shock when shopping for alt data. There is strong demand for alt data, but few providers. Plus, building alt data sets can often be a very cost-prohibitive process.
2. PAINFUL PROCUREMENT PROCESS — Not just a barrier to adopting alt data, but a burdensome and sluggish procurement process is a challenge to buying any new data set.
3. NO TIME TO EVALUATE — Obviously before you’re going to onboard any new data, you’re going to obtain a sample to evaluate. But what if there are no qualified quants or analysts available to do the evaluation?
4. LACK OF MGT BUY-IN — Driven partly by a perception of a lack of sufficient historical data to analyze, and/or a lack of success stories of alpha being discovered in alt data, buy-side management teams are often slow to support alt data initiatives.
5. HARD TO COMPREHEND — Even if a firm has the internal resources to conduct an evaluation of alt data, the analyst(s) may not have the experience to properly understand the alt data. So they are unable to comprehend how they could extract alpha from the alt data.  
6. INCOMPATIBLE WITH EXISTING SYSTEMS — Not all alt data comes “research-ready”, so digesting alt data can be tough sometimes. DIH knows this first hand as we have mapped all of our alt data to our security master.
7. LACK OF DATA INTEGRATION RESOURCES — Again, a lack of internal resources can derail the adoption of alt data because there simply are not the hands on deck for such data integration projects.
8. PERCEPTION OF INCOMPLETENESS — Perception often becomes reality, so if management perceives alt data to be incomplete, or lacking sufficient historical data, that narrative can become a barrier to adoption.

Conclusion

​There may be challenges for some institutional investors to adopt alternative data, but the competition for alpha is always stronger. So even if your firm doesn’t embrace alt data, your competitors will. It’s for that reason we expect to see broader adoption of alternative data going forward.

If you’d like to learn more about the various Alternative Data we offer at DIH, please contact us.