The following is a guest article by Jeff West, the founder of StreetFeeds, a leading provider of product development, licensing, and distribution services to the financial market data industry (www.streetfeeds.com). StreetFeeds has partnered with Integrity Research Associates to market our various research and advisory services to the buy-side and sell-side. Jeff will contribute occasional articles, focused on his perspectives on all things data related.
Alternative data has become ubiquitous on Wall Street, especially among quantitative hedge funds. However, in the past few years many new client segments have started to include the use of alternative data as a key part of their business decision making processes.
The Changing Face of the Alternative Data Industry
In the past, most investment professionals built models and did their research, using conventional, widely available data sets, like financial statement data and historical stock prices. The advent of big data tools and enhanced computing power, have allowed larger and less structured, unconventional alternative data sets to be studied, in search of leading edge insights and advantages in the investment process.
Enterprising alternative data providers are searching for new markets to sell their data and are always on the lookout for new data sets that may be capable of improving alpha. As with any product, opening new markets to alternative data increases the potential revenue that can be generated.
Private Equity Adoption of Alternative Data
The private equity industry is a new, largely untapped market for alternative data. But these buy and hold investors need an advantage over their PE competitors as much as high speed trading hedge funds do. Increasingly, they are turning to alternative data sources. In fact, the sometimes more subjective nature of alternative data can make it even more useful to private equity firms.
The above chart from a survey conducted by AlternativeData.org shows that 27% of PE firms surveyed currently use alternative data in various parts of their research process, while another 25% expect to use this data in the near future.
Well known alternative data sets such as credit card receipts and traffic patterns, frequently used by hedge funds, can also help PE firms. Such data provides valuable competitive intelligence, helping PE investors analyze their portfolio companies’ strategic direction and make better long term decisions.
Improving valuation methods for private companies is an age old challenge for the PE industry as well as bankers and business brokers. Increasingly these firms are turning to alternative data to help determine intangible assets in making valuations, and with good reason. Even public company values have grown increasingly dependent upon intangible vs tangible assets. In fact an Ocean Tomo study found, that the intangible portion of assets on the balance sheets of S&P 500 companies have grown from 17% in 1975 to 87% in 2015.
Exacerbating this issue is the fact that, since they don’t report publicly, traditional private company data used in valuation is far less reliable and available than public company data, making a strong case for the use of alternative data sources to augment traditional sources.
One firm benefiting from this trend is Second Measure, an alternative data provider which is backed by Goldman Sachs, Citi Ventures, Jeffries and others. Second Measure has carved out a niche helping to benchmark and value private companies by studying consumer spending habits.
Credit Underwriting by Banks, Credit Unions and Non-bank Financial Firms
The Cato Institute writes that alternative data can expand access to credit to more consumers. In fact Dan Quann, a Cato scholar says “Underwriting models that include alternative data can increase lending volume, lower interest rates for borrowers, and improve the accuracy of default predictions. In short, alternative data can make lending more plentiful, more affordable, and sounder ”.
The Federal Reserve, Consumer Financial Protection Board (CFPB) and the FDIC all seem to agree with Mr. Quann. They issued a joint statement last month noting the benefits of alternative data to help consumers expand access to credit, and obtain additional products at more favorable pricing and terms.
Equifax, which owns alternative data provider DataX, estimates that about 10% of adult Americans do not have sufficient credit history to allow the use of traditional credit to evaluate their risk. By turning to alternative sources, firms are able to analyze payment history for a consumer’s everyday bills, such as cable television, utilities and cellular service. In effect alternative data has allowed banks and insurers to tap this large market of previously “invisible” consumers.
The Insurance Industry
Actuaries and underwriters have always been awash in data, using it to determine risk for the insurance industry. But even the famously conservative insurance industry, has begun to augment their traditional forms of data, with alternative data sets.
The world of life, health, auto and home insurance, is also benefiting from the adoption of alternative data. Here the insured generate their own data, and contribute it to their insurance carrier in exchange for a discount. One program monitors a person’s Fitbit type activity tracker, monitoring their heart rate and other health indicators and exercise habits, to determine their fitness, and adjust their life and health insurance rates.
Other insurers install monitors in cars, allowing them to track driver safety habits to help determine automobile policy rates. Gartner Group points to alternative data provider Octo Telematics Drivability Score, stating it provides a 10-12 times increase in risk assessment.
The increase in the availability and adoption of alternative data has become a tsunami. While the alt data wave spreads to other industries outside of large buy side firms, it also moves down stream to smaller institutions in those industries.
As demand for alternative data increases by orders of magnitude, so does the supply of potential data sets made available. Few want to be left behind this tectonic shift, and in order to succeed going forward, even fewer can afford to be.