When traditional data falls short, Alternative Data promises to save the day
As questions like:when will life return to normal, when will the vaccine arrive, when will the economy look up, is there a recession round the corner, or where is the next pandemic going to come from – jostle in our minds, investors, analysts, fund managers, investment bankers and economists are turning to non-conventional sources of data to make sense of the present and figure out the future. They are looking at Alt-Data or “Alternative Data” to find these answers; and at times, analytics from Alt-Data is proving to be quite accurate. Critics however argue that Alt-Data carries too much noise. Supporters say that there is a pattern even in this noise.
As the debate rages on, business is booming among the nearly 1,500 Alt-data vendors. Hundreds of datasets offer options such as sentiment data on financial markets based on Twitter and StockTwits; web traffic data from company IP addresses to watch research topics by employees; and natural language processing (NLP) to analyse news, press releases and financial social media. Stimulating case studies and use cases are creating a surge of interest.
SpaceKnow describes itself as a company that empowers decision-makers with ultra-large-scale planetary analysis. It offers a service that uses satellite image processing technology to monitor crop and agricultural produce. The same is now being used to check on the level of Chinese manufacturing. Through algorithmic imagery analysis, SpaceKnow created the China Satellite Manufacturing Index (SMI) to compete with the current state-run indices – the China Purchasing Managers Index (PMI) and the Caixin PMI. The two PMIs are created by using survey data from managers, collected by the National Bureau of Statistics of China. SpaceKnow uses satellite imagery datasets consisting of over two billion observation points to create an index that, they claim, more accurately predicts Chinese manufacturing for investors.
Analysis of historical data over a 10-year period shows a very strong correlation of the SpaceKnow data to both PMIs. This is just an example of Alternative Data, which is rapidly picking up usage in specialized fields. In December 2019, a Canadian analytics company which tracks outbreaks of diseases across the world, used air traffic data to identify the Coronavirus pandemic just breaking out in Wuhan, much before WHO (World Health Organization) or the Chinese authorities informed the rest of the world.
Alternative Data is defined as non-traditional data that can provide an indication of future performance of a company beyond traditional sources, such as company filings, broker forecasts and management guidance. This data can be used as part of the pre-trade investment analysis, as well as for helping investors monitor the health of a company, industry, or economy. Many investors already consider Alt-Data to be just as essential as fundamental data for their financial analysis and insights.
Alt-Data has become especially popular among the financial services and investment banking sector. Hedge funds say that Alt-Data detected the economy’s collapse much earlier than conventional data and, they hope, will also be faster to detect any recovery. Indicators have included comparisons of social media posts in China with government statements to gauge the virus’s impact.
Some complain that Alt-Data’s signal-to-noise ratio is prohibitive. But to a savvy data analyst, noise only prompts another question, “What patterns in this noise can I find?” Other critics warn that the data is more likely to be corrupt – but good data analysts always stay alert for that.
A multibillion-dollar industry offering unusual data such as satellite imagery and measurements of social media sentiment is enjoying strong surge in demand as hedge funds and companies hunt for clues on how to tackle the Coronavirus crisis. Many investors have turned to Alternative Data for niche information beyond standard financial market indicators or statistical releases — after finding official numbers too slow in reflecting the collapse in economic activity due to COVID, and the recovery. Total annual spending on such information by fund managers alone was predicted to reach overUS$1.7bn this year, up from US$400m three years ago, according to Alternativedata.org.
Aspect Capital has been a believer in Alt-Data for several years;however,its recent experience has strengthened that view. Its news-reading algorithms spotted weakening sentiment on the Norwegian krone, which moves with oil prices, in mid-February. By the end of the month, its Systematic Global Macro fund had gone short the currency against the dollar, and it built this position into early March. It then profited as oil prices dropped, and the krone slumped, pushing the dollar up from 9.2 krone per dollar on March 6 to above 12 kroneon March 19.
Whether the data is conventional or “alt,” it’s subject to human judgment. The choice is not either to abandon Alt-Datain favour of strictly conventional data nor to embrace it with abandon. Of course Alt-Data can safely be used, but only when backed by domain knowledge that helps to know when a ringing in the ear has real meaning. Alternative data is not a new concept. Merchants in ancient Babylon measured the depth and flow of the Euphrates river to try to get an edge in their trading, after discovering a correlation with the supply of commodities.
Like so many other powerful tools, Alt-Data and conventional data can be combined to derive great effect, but only with the warning:“For use by domain experts or expert data analysts only; may cause undue distress or foolish optimism”. Over time, what is Alt-Data today will become conventional data as more evidences pour in over its worth.