​Five Things to Know About Hedge Funds and Alternative Data:

More and more hedge funds have adopted the use of alternative data in recent years. Among others, investors use non-conventional data sources to improve their decision-making, discover new investment opportunities, and even improve portfolio returns. With the explosion of data in the internet era, it is not surprising that institutional investors seek to obtain information advantages. Let’s find out five things you should know about hedge funds and alternative data. 

• Alternative data supplements traditional decision-making

One of the main top hedge fund trends is that hedge fund assets are expected to enjoy continuous growth and outperformance this year. It is not news that alternative data has disrupted this industry as investment managers continuously exploit new technologies to find, collect, and analyze information. 

However, this information does not replace the conventional data sources, such as economic reports and companies’ financial statements. Alternative data is used to supplement these existing data and improve the decision-making by providing a deeper insight into the industry and market. 

• Hedge funds will continue mass adoption of alternative data

More than 90% of the information available today was generated only in the past two years. In addition to this, professionals expect data to grow by 2.5 quintillion bytes each day. With such an informational abundance, professionals in this industry safely predict that alternative data adoption will be dramatic in the next five years. 

Given the virtually endless supply of data, it is obvious that availability is not one of the main challenges. Instead, hedge fund managers will have to find the correct data relevant to their objectives, capture it, and extract enough value from this information to justify the investment in alternative data. 

For example, large funds will have to invest massively in intelligent technologies, such as artificial intelligence, to extract value from alternative data. Smaller players, however, may lack the resources to obtain such cost-intensive assets. These firms can catch up easily with their larger competitors by outsourcing the collection, management, and analysis of alternative data – each step apart from the investment decision-making itself. 

• Learning more about consumer behaviors

One of the main uses of alternative data in 2020 was related to consumer behavior changes in the context of the pandemic. A report shows that organizations used alternative data collected from social media, wearables, applications, and others to calculate the changes in consumer interests and purchases. It was concluded that the segment with the highest 2020-2026 CAGR is the one related to debit and credit card transactions. 

In other words, hedge funds can access specific data, such as transactions and foot traffic data, that can lead to tactical decisions. This drives performance and helps hedge funds and other investors make better decisions by combining alternative data with traditional information to determine assets’ performance. 

Another example is the use of social media information and search engine results. Hedge funds use this information to predict the results of quarterly earnings releases and other firm-specific events.  

• New opportunities for active investment management

According to the top hedge fund trends, allocations to hedge funds have decreased significantly in the past years. However, these are now on the rise due to the better performance of active management compared to passive management, especially during the uncertainty of the pandemic. 

This may be further fueled by Collective Intelligence Investing (CII), a method of collecting alternative data from crowdsourcing platforms and online communities on social media. It is rapidly gaining popularity, leading to new opportunities for active investment management. 

• Alternative data reveals more than financial performance

One of the main benefits of using alternative data, apart from having more information for analysis, is that it can improve the quality of predictions. For instance, traditional data, such as a firm’s financial statement, shows the company’s current financial performance with little to no insight into what may happen in the future. 

However, hedge fund managers who access and use alternative data are able to fine-tune their predictions. For example, analyzing social media posts can show you how consumers generally feel about the brand. Specifically, companies can see whether the final consumers are the ones targeted by the company, and whether they are satisfied with the company’s products and services. 

These deeper insights into a given company are extremely broad and frequent, always up-to-date. In other words, alternative data is always fresh and updated so that analysis can be conducted at any time, not only periodically, such as when the company releases quarterly results.

Summary

All in all, it is not surprising that more and more hedge funds have adopted alternative data collection and analysis to generate alpha. This information is readily available online, helping managers to obtain better performance and trend predictions. Undoubtedly, adopting alternative data can be resource-intensive, but current evidence indicates higher alpha generation.