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What is Alternative Data and Why is it Changing Finance?

While investment firms and financial advisors have typically relied on traditional information sources like SEC filings and press releases to make investment decisions, there’s a sea change going on in the industry.

Investors are increasingly turning to alternative data sources for faster insights and a fresh perspective in the search for better and more contextual information that delivers a market edge.

Because the internet and global connectivity have made markets faster and less predictable, market opportunities are often far advanced when they reach traditional data streams. Alternative data provides an opportunity to secure critical insights about market movements before they happen, and that’s why the finance industry is embracing it.

But what exactly constitutes alternative data, and how does it provide advantages beyond the steady and trusted data sources finance firms rely on? Here’s all you should know.

What Is Alternative Data?

Alternative data refers to non-typical data streams and sources that:

Have not heavily factored in financial advice or investments before now
Have proven valuable because of the additional context and earlier insights they provide
Investors use to guide strategies and investment tactic

As a result, alternative data comes in all shapes and forms and can include anything from social media sentiment to ESG (Environment, Sustainability, and Governance) data and geospatial information.

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For instance, in a recent viral trend on TikTok, traders made market moves based on analysis of Congress members’ actions and disclosures.

While typical or traditional data streams, such as financial reports and news stories, have constituted the bedrock of the financial industry for centuries, alternative data presents fresh data inputs and a broader picture. It also provides an opportunity to spot insights from far off and enter favorable market positions earlier.

For example, an investment firm might anticipate that a company will miss its quarterly earnings target from data analysis that shows slowing POS activity, and the firm can position portfolios accordingly. Likewise, patent filings and even private jet activity can indicate that a company is about to make a major market move (even one under wraps), letting intrepid investors place an early bet.

4 Types of Alternative Data

Alternative data sources can include any data type or source beyond traditional information points. The data classes that fit into the category are fluid and constantly changing, although some alt-data types have proven themselves in the industry. These include:

Social sentiment: Markets turn on several factors, but one crucial industry mover is what people think. Showcasing the value of this data type, Peloton suffered an uptick in negative product reviews in the months before a treadmill recall tanked the company’s shares by 15%. Investors tracking that data would have seen the potential for a fall long before and acted accordingly.
Web traffic: SimilarWeb, an alt-data provider, specializes in culling datasets that indicate what online products consumers are using, where they are using them, and the implications of observed traffic. Investors apparently think a lot of this data type, as SimilarWeb became the first alt-data company to go public in May 2021.
Jet tracking: As mentioned above, jet tracking has proven itself in the alternative data space, most notably when analysts predicted Berkshire Hathaway’s $10 billion investment in Occidental after the company’s private jet landed in Omaha.
Geolocation: Same as what people think, where people go is also an important indicator of deeper events. For instance, investors might employ geolocation data to track store foot traffic, analyze consumer preferences (say, where they want to shop), and predict market trends.

Financial firms also use other data sources, like credit card transactions and POS information, to determine customer health, transaction value/volume, and potential earnings. Likewise, satellite imagery can be pivotal in anticipating the size and scale of company projects and their potential impact on revenue.

The Growing Use of Alternative Data in Finance

While alternative data has always played a role in finance, it didn’t become mainstream until the “quant quake” of 2007, according to Yin Luo, vice chairman at data firm Wolfe Research. Investment was a herd activity at the time, and quantitative hedge funds typically congregated around the same stocks. But when a massive sell activity began, everybody ended up selling, tanking the market.

Later, the proposition spread that new data sources could help provide new information that enables smarter investing decisions. A few years later, a prominent London hedge fund would become one of the first to direct investments based on studies that showed a connection between the Dow Jones Index and Twitter mood.

Today, alternative data is a massive opportunity in finance, delivering insights potentially worth trillions of dollars to investors. Statistics indicate that there are 20 times more alternative data providers than in the early 90s, with over 400 active data providers in the market. Likewise, about half of investment firms employ alternative data currently, and those figures are expected to expand as more firms explore new technology.

Alternative data enjoys multiple successful use cases in finance, some of which include:

Investment research and deal sourcing: Firms use alternative data to identify potentially profitable deals. The contextual information that alt data brings allows firms to appreciate the risks and opportunities in a transaction correctly.
Demand forecasting: How long will an investment continue to remain profitable? Alt data-led demand forecasting helps firms answer that question by studying transaction data, foot traffic, store hires, etc.
Portfolio management: Conventional portfolio management theory favors a proactive approach toward investments. While firms take a long view of their assets, alternative data can be valuable for monitoring when it’s time to accumulate more or offload soon-to-bust assets.
Due diligence: While stock markets have come a long way from the duplicitous ways of the early 1900s, the truth is that companies often understate negative information. Alternative data presents a way to get at facts that might not be obvious from traditional data sets like SEC filings and financial disclosures.

Alternative Data & Finance: A Perfect Match?

Answering that question requires understanding how alternative data is currently used in the industry. Alt data is essentially big data due to its overwhelming size and “dirty” nature. It must typically be collected, cleaned, tagged, and analyzed before any value can be wrung from it.

But as is the case with big data in all other industries, that process is prohibitively expensive and often beyond many investment firms’ reach (or convenience). While data providers help provide these services, they can often come at a premium – Thinknum charges up to $50,000 yearly for a single data set (such as social media sentiment).

Yet even when bought, such data might not readily display the insights that companies need. As a result, firms must rely on a further intermediary to validate data sets and distill valuable insights from them before taking delivery of hopefully now-usable data.

Although these challenges may be intractable for all but the largest and wealthiest firms, the good news is that it’s likely a problem of scale. As the industry grows larger and more focused, we should see more value for money and potentially more competitive prices overall.

The bottom line

Ultimately, alternative data can potentially deliver better results and performance for firms prioritizing these data sources – so long as they can surmount the challenge of procuring usable data sets.

Alternative Data Executive Search | Cowen Partners

Cowen Partners Executive Search has extensive experience in the alternative data space. Our hands-on executive recruiters have experience working with private, public, pre-IPO alternative data companies.

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What Is Alt Data & Why Is It Changing Finance?