18 September 2018

Alternative data: breathing new life into portfolio performance

By Marianne Elie

By now, you’ve certainly heard some of the buzz about alternative data, one of the past year’s hottest topics in the asset management world. Many firms are interested in it as a means to generate alpha, while others have had mixed experiences and still others are taking a wait-and-see attitude to determine if it adds measurably to investment research and portfolio performance.

Yet for all the attention alternative data has received, there are still some misperceptions about it in the market. Chief among them is that it is somehow associated with alternative investments – which is not the case, according to Mary Storrs, Principal and Research Director of Cutter Associates.

Mary led a panel discussion on the topic last week at SS&C Deliver in Las Vegas, along with Merchant Forecast CEO Dan Hess and Jatish Panji of Halcyon Capital Management.

Alternative data refers to any unstructured or non-traditional information. It goes beyond the financial data companies report in their quarterly or annual statements. One of the major applications of alternative data is scoring companies on environmental, social and governance (ESG) performance, based on sentiment beyond what companies report about themselves.

In the endless search for alpha, research analysts are factoring alternative data into their forecasts in increasing numbers. Some 350 companies are in the business of providing alternative data in some shape or form. Due diligence on providers is a challenge since many have very short track records. Buying patterns among users vary based on budget and complexity of investment strategies. Average spending on alternative data among institutional asset managers has more than doubled over the past two years, and is expected to keep growing rapidly as investors demand it. 

For hedge funds, whether to incorporate alternative data in investment strategies is ultimately the decision of portfolio managers and director of research. It comes down to a firm’s cultural preference, with the main pushback being that alternative data can be “noisy” rather than constructive.

All the hype about alternative data has generated a ‘fear of missing out’ among investment firms. There’s a lot of pressure to jump on the bandwagon, and a concern that firms that don’t use it will be at a disadvantage. One analyst went so far as to say firms were negligent if they didn’t use it. During the panel discussion, we ran a quick poll of attendees and found that 83% agreed with that statement.

The panelists thought the term negligent might be a little too harsh, but that alternative data can represent important information and firms should have a plan for it.

The big challenge with alternative data is the sheer volume of it and the difficulty finding the few nuggets that can potentially drive alpha. To derive meaning from alternative data requires technology, such as natural language processing, artificial intelligence and machine learning.

“People simply cannot process such vast quantities of data on their own,”  said Mary Storrs.

Key points from the panel include:

  1. Alternative data has the potential to breathe life into performance and represents the future

  2. Alternative data helps investment managers by looking at companies instead of tickers. This means going deeper than earnings and thinking creatively about investments

  3. Many firms may also look simultaneously at artificial intelligence tools if they really expect to derive value from the enormous volumes of alternative data available

In a live poll of session attendees, only around 17% said their firms were actively using alternative data to inform their investment decisions. Some 50% were starting to analyze or consider it, and 33% had no plans to use it.  It seems likely that there is more to come as alternative data becomes easier to obtain, analyze and be put to productive use.