Investment Operations

Half of Hedge Funds Use Alternative Data to Gain Competitive Edge

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  • Use of alternative data is on the rise, including analysis of consumer spending data and weather patterns
  • 1 in 2 (53%) of hedge fund managers surveyed use alternative data
  • Alternative data will be adopted within the industry within 1-5 years
  • Regulatory headwinds could cloud the horizon, such as data owner consent and privacy

The Alternative Investment Management Association (AIMA), in collaboration with fund services and technology provider SS&C, has published an in-depth report which explores the rate of adoption of alternative data within the global hedge fund industry. “Casting the Net,” how hedge funds are using alternative data was informed through the most comprehensive survey to date of 100 hedge fund managers globally, accounting for an estimated total of $720 bn in assets under management. The report includes insights from conversations with industry leaders and alternative data providers.

Alternative data is unconventional or non-market data that doesn’t fall within the realms of traditional financial and economic data. Examples include data from consumer spending, weather patterns and satellite imagery. Due to factors such as the increase in the amount of data itself and advancements in data science, the number of alternative data providers has now grown to over 400 (in 2018) up from just 20 in 1990.

Of the total number of managers surveyed, 53% use alternative data, with 25% of these considered to be ‘market leaders’ or hedge fund managers that have been using this type of data for more than five years. The remaining 75% of users have been using alternative data for less than half a decade.

Analysts say gaining a legitimate information edge is what helps hedge fund managers meet their clients’ investment needs, helping to manage risk to generate alpha efficiently. The proliferation of alternative datasets offers new opportunities (and challenges) for managers who want to remain a step ahead of the competition.

The analysis revealed concerns around regulatory and compliance challenges on the horizon, including data owner consent, privacy issues, intellectual property rights infringement, consumer protection and practices that could provide an unfair advantage. Frameworks around the governing of data are changing rapidly.

Some of the key findings include:

Top three alternative data sets used by hedge fund managers:

  • Consumer spending and lifestyle data: e.g., retail footfall in shopping centres and malls, credit card receipts
  • Web-crawled data: extracting information stored within web pages
  • Data sourced from expert networks: bespoke research that may include data from unconventional sources
  • 10% of managers use climate-related data

Key opportunities for using alternative data:

  • Performance: 69% of market leaders use alternative data to help them generate outperformance vs. 44% of ‘the rest of the market.’
  • Risk management: 23% of market leaders use alternative data to help them improve risk management processes vs. 36% of ‘the rest of the market.’

Key challenges in using alternative data:

  • Sourcing: 54% of market leaders find it difficult to source quality alternative data sets vs. 62% of ‘the rest of the market.’
  • Regulatory headwinds: 20% of market leaders reported regulatory and compliance challenges vs. 15% of ‘the rest of the market.’

“The world we live in is becoming more and more digitised and, as such, the amount and types of information that hedge fund managers can use to either research investment ideas or improve their understanding of current portfolio positions will also expand,” said Jack Inglis, CEO of AIMA. “Hedge funds have long been the innovators of the asset management industry and the first to adopt new approaches to technology, so, unsurprisingly, many are already using alternative data to research investment ideas and improve their understanding of current portfolio positions. The immediacy of alternative data, in comparison to the information lag from working with more traditional data, is particularly helpful in moments like this when markets cease to function normally. There is already a great sense of optimism amongst hedge fund managers enjoying the benefits of a deeper knowledge of trends; however, managers know further challenges are ahead as they tackle how best to gather this type of data and continuously derive something meaningful from it,” he added.

The research shows that for alternative data to become more broadly accepted, several factors need to fall into place. For example, 62% of market leaders and 87% of ‘the rest of the market’ believe that improvements in the reliability and relevance of alternative data are needed before the industry embraces it further.

And yet, the analysis shows that there is general optimism regarding how quickly alternative data will be adopted within the hedge fund industry: most managers who are users of alternative data expect this to happen between the next 1 to 5 years.

The full report is available here.