Alternative Data, Data Monetization

How Hedge Funds Use Alternative Data in the Investment Process

The Alternative Investment Management Association (AIMA) and funds services provider SS&C jointly published a report called ‘Casting the Net: How Hedge Funds are Using Alternative Data‘, exploring all of the ways hedge funds are now using alternative datasets like social media trends, weather data, satellite imagery, credit card transactions data, etc. in their financial models and businesses.

In the forward of the report, Jack Inglis, AIMA’s CEO, and Michael Megaw, Managing Director, Regulatory Analytics and Data, SS&C Technologies noted “While traditional sources of economic and financial knowledge, such as textbooks, industry literature and established data bases are excellent in providing a level-playing field for hedge fund managers, going above and beyond these commonly used sources is crucial for managers to remain innovative and therefore, to stay competitive.”

The goal of the study is to provide an in-depth analysis on how alternative data is being used by the hedge fund industry to further discuss its broader adoption. Topics explored include how widely adopted alternative data is within the hedge fund industry, what are the main uses that managers are employing alternative data for, the opportunities and challenges that these data sets present and what the future holds for alternative data within the hedge fund sector.

The underlying methodology of the study included surveys and interviews of 100 hedge fund managers globally with $720 Billion AUM collectively in assets across long/short, event driven, and macro strategies, among others.

Key Findings

  • more than 50% of hedge fund managers are using alternative data to gain a competitive edge
  • about 27% of those polled manage more than $5 Billion AUM, while 25% of them are considered “market leaders” or hedge fund managers that have been using alternative data for more than 5 years
  • 69% of the market leaders now use alternative data to generate outperformance or alpha
  • 23% of them employ it in their risk management process
  • 54% of market leaders are still struggling to source quality data
  • 15% of the market report regulatory and compliance challenges (GDPR, MNPI, data owner consent, privacy issues, IP rights infringement, consumer protection, etc.)
  • 77% of market leaders confirmed that it is difficult to back-test historical data
  • top 5 alternative data sets used by market leaders include:
  • long/short equity funds tend to use sentiment data, online reviews and payments data while quant hedge funds prefer weather patterns, satellite imagery, logistics data, and web scraped data
  • climate change is now a major policy challenge and climate-related data is starting to become more relevant for hedge funds. About 10% of survey participants confirmed use of weather pattern data
  • ESG data is expected to become more prominent as an alternative data signal
  • moving forward, about 61% of market leaders and 82% of the rest of the market anticipate alternative data to become more widely adopted among hedge funds in the coming 1-5 years which, “in financial markets terms means ‘now'”

“To Do” List for Managers

The study also offers a “to do” list for managers who either want to use alternative data or are currently in the process of strengthening their internal onboarding policies. Some examples included:

  • hedge funds have developed strong policies and processes around onboarding data vendors and using the alternative data in way that minimizes legal and compliance risks involved
  • many hedge funds start the process off with an initial interview of the data provider, focusing on data source/methodology, privacy and MNPI issues and legal protections for clients
  • funds also conduct a formal compliance review with a due diligence questionnaire either designed by an external party or internally
  • data trial licenses include key issues like personal data protection, prevention of insider trading and the “right to use data”
  • additional preparation involve ensuring proper infrastructures to onboard the data (data scientists, digital platforms, software tools, etc) as well as preparing the data for review and analysis (conducting a proof of concept, cost-benefit analysis, tagging the data, assessing use and impact, etc)

Altdatainsider compiled a similar checklist for funds here and data vendors selling to hedge funds here.

Bottom Line

The study outlined broad optimism around hedge fund use of alternative data in the years to come. It also highlighted belief that non-conventional data will become more mainstream. Hedge funds will need to continue to pioneer innovation both in the use and analysis of such alternative data as well as in navigating through the regulatory changes and challenge in finding quality data sets.

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