What Is Alternative Data?
Alternative data is data gathered from nontraditional sources. For investors, that generally means looking beyond company filings and what brokers say to get an edge in the market.
Examples of alternative data include credit card transactions, social media commentary, product reviews, and satellite imagery. These kinds of things can help to formulate trading ideas and contain information capable of moving share prices.
- Alternative data is data gathered outside of traditional sources such as company filings and broker research notes.
- Information that comes from unconventional places and is capable of moving share prices falls into this category.
- Examples include credit card transactions, social media commentary, product reviews, and satellite imagery.
- Demand for alternative data has rocketed, leading to more providers entering the market, greater affordability, and better technologies.
- Drawbacks include selection bias, threats to privacy, and significant time could have passed before the findings become widely known and have an impact on share prices.
Understanding Alternative Data
Alternative data is called “alternative” because it doesn’t come from traditional sources. In the investing world, that generally means material distributed by a company’s investor relations department, such as management guidance, and marketing presentations, as well as earnings calls, and broker research notes. Pretty much everything else can be considered alternative.
Classic examples of alternative data include comments made on the internet, weather forecasts, satellite imagery, information collected by internet of things (IoT) sensors, employee benefit plans, and corporate jet movements. This type of information is out there but not necessarily easily accessible and is capable of changing sentiment in companies listed on the stock market.
Signals buried in the data generated by digital platforms have become hot property among investors. In the battle for alpha, market participants will consider any nugget of information, increasing demand for alternative data and the companies capable of supplying it.
This is no longer a niche, small market. Buy-side firms, such as mutual funds, hedge funds, and pension funds, now reportedly spend billions of dollars acquiring this information. And that has led to more providers entering the sector, boosting competition, affordability, and capabilities.
The estimated compound annual growth rate of the alternative data market from 2022 to 2030.
Examples of Alternative Data
Any insightful information about a company that doesn’t come from traditional sources is considered alternative data. Plenty of things fall under this category, with some of the most useful and popular including:
Social Sentiment and Product Reviews
A lot of information is shared on the internet, and it can be used to gauge popular opinion about companies trading on the stock market. Likes, comments, and reviews paint a portrait of how paying customers feel about the goods or services offered, are influential, and can function as an indicator of future revenues.
Web Traffic and App Usage
A sudden spike or drop in website or app visits can be informative. Views don’t necessarily translate into purchases, though they do signify interest—and that’s generally a good thing for a company and its share price.
Taking images of planet Earth from outer space serves all types of purposes. When it comes to investing, it can, among other things, be used to check out construction projects, the prosperity of oil fields, how many cars are in store parking lots, and monitor natural disasters and other issues that impact supply chains.
Internet of Things
Connecting devices to the internet is a game changer not only for product efficiency but also maybe for investors. Once they are online, the information collected is recorded and can be shared. Some of this data will be useless. Other bits, however, could prove really insightful and make those privy to them lots of money.
A point of controversy surrounding alternative data is that it may violate privacy, which could have repercussions later on down the line and lead to tighter regulation.
Keeping tabs on the movements of certain people is potentially very lucrative. Takeovers, private equity deals, and high-profile investors buying stakes in companies can have huge repercussions for share prices and may be spottable beforehand by tracking corporate aviation movements.
How Is Alternative Data Collected and Distributed?
Alternative data is plucked from various sources, including sensors, satellites, public records, the internet, financial transactions, and mobile devices. Technology developed by specialist providers is mainly used to collect the raw data. The findings are then typically assessed by a combination of technology and humans before being packaged for consumption.
There are now hundreds of companies that specialize in alternative data. Some of them focus on specific things, such as social media or private jet movements, while others offer more complete packages.
Who Uses Alternative Data?
When alternative data started to take off in the mid-2000s, its recipients were mainly hedge funds. Back then, alternative data was prohibitively expensive and catered exclusively to wealthy traders looking to make quick moves and profits.
Nowadays, alternative data is a common fixture in the offices of all types of investment firms. Its main users are algorithmic traders, or quants, who leverage the data to build computer models predominantly for trading equities. However, longer-term, buy-and-hold investors are taking positions, too, based on alternative data findings.
Industry insiders also say that companies are frequently basing corporate decisions on the information churned out by alternative data and that private equity firms tap into this data when weighing up targets and striking deals.
Disadvantages of Alternative Data
Alternative data can be very lucrative if used correctly. However, it’s by no means flawless and, like any other indicator, should only be followed up on after careful due diligence and other analysis.
One of the biggest drawbacks is the risk that the data only tells part of a story and is not truly representative. While technology keeps on improving, it may not be capable of spotting everything and could overlook some important information.
Other notable downsides of alternative data include concerns that it is acquired by invading privacy, and that it can take quite a bit of time for interesting findings to reach the mainstream and have an impact on share prices.
How Do You Find Alternative Data?
Retail investors generally have two options:
- Do some digging themselves using the resources available to them.
- Pay a specialist firm to send them their data.
Why Is Alternative Data Important?
The more information you have about a potential investment, the better. Today, thanks to technological advancements, it’s possible to build a much more complete picture of a company that stretches way beyond its most recent financial statement and corporate communication.
How Much Has the Alternative Data Market Grown?
Demand for alternative data has rocketed over the past decade or so. Previously, this kind of information was only accessible to a select few investors. Now, everyone wants to get in on the action, which has led to more options and greater affordability.
The Bottom Line
Alternative data is something that all investors should be aware of. When we buy shares, we are betting that the company’s earnings will rise and that this will lead it to increase in value. Knowledge is key here, with the probability of making the right call increasing when we have more information about the subject.
Traditional data sources such as financial statements will always be a critical component of analyzing a stock. But they tend to be backward-looking and self-promoting and only tell us so much. To really gain an edge and have a greater chance of making money, it’s necessary to dig deeper. That’s where alternative data comes in handy. When used properly, data extracted from nontraditional sources can present us with a more complete picture of a company and its prospects.