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How alternative data is helping investors make smarter deals

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It may not come as a surprise that the private equity and hedge fund industries were affected by COVID-19, albeit in opposing ways. According to PitchBook, U.S. private equity activity in 2020 totaled $708.4 billion over 5,309 deals, which represented year-over-year dips of 7.3% and 3.4%, respectively. For the first time since 2009, both deal-making value and count decreased. In contrast, the hedge fund market was luckier – in 2020, hedge funds produced their best return in a decade with 11.6%. After a decline in the beginning of the year from effects of the pandemic, hedge funds ended 2020 on a strong note. 

Despite the difficulties of 2020, I predict that in 2021 there will be a rebound of fundraising for private equity firms and a continuation of strong momentum for hedge funds, thanks to an increased use of alternative data. During 2020, private equity activities increasingly relied on alternative data and we are already seeing a growth of 21% so far this year. 

In a nutshell, alternative data is made up of non-traditional data sources that can provide real-time insights into an organization or a firm. Examples include website traffic, social media activity or even something like import or export records. Essentially, it’s data that’s sourced from publicly available, online destinations and offers a much more immediate and creative way to identify the financial prospects of a company or market. Since it is up to private equity firms and hedge funds to be certain about the investments they are making, it certainly makes sense for them to turn to the largest source of information – the online sphere – to plan their investment strategy with certainty. 

How alternative data can be used for decision-making 

Alternative data has been gaining traction in the world of private equity firms and hedge funds. According to a recent report, 69% of hedge fund market leaders use alternative data to generate outperformance, and 23% use it for their risk management processes. While these numbers are strong, they still reflect the fact that alternative data has not fully been adopted by private equity and hedge fund managers. This could be attributed to some misconceptions about the data collection process. 

Since private equity firms are involved with a wide range of deals, they’re constantly looking to collect trustworthy data. And, since private equity firms are often handling large-scale deals (compared to smaller investments from venture capital funds), it’s all the more important that investors are using alternative data to back up their decisions. 

On the hedge fund side of things, both fundamental and quantitative fund handlers use alternative data to guide their decision-making and make sense of the market. Fundamental handlers can quickly absorb data to offer an immediate snapshot of the market. On the other hand, quantitative fund handlers focus more on market algorithms over an extended period of time. This means that as time goes by and more data is collected, quantitative funds have more information with which to make better sense of the market. The dual benefit of alternative data is that it can be used for creating snapshots as well as long-term trends. 

Alternative data is already being used to drive decision-making – and it’s showing impressive results. In 2020, hedge fund Sender Company & Painters gained 30% just by looking at real-time data on what stocks Robinhood users were buying and selling. In 2018, database company Thasos Group tipped off its hedge fund clients that Tesla was working around the clock to increase production of their Model 3 Sedan. How did they know? They tracked the smartphone location signals within Tesla’s headquarters and found a 30% increase in the overnight shift. This led to Tesla’s stock going up 9.1% the day after they released their quarterly profit at the time. 

These examples reflect one fact: alternative data is there to be utilized and can transform your results.   

How funds can collect alternative data 

When sourcing alternative data, it’s imperative that private equity firms and hedge funds have the most up-to-date, reliable data possible – otherwise, they could be basing decisions and deals off of information that’s no longer relevant and accurate. 

Alternative data sources differ from traditional data sources because they are typically rapidly updated in near real time rather than a few times a year. Traditional data, like company earnings, are no longer a reliable source on which to make decisions because they are considered out of date soon after being released. In today’s fluctuating market, data that’s even a week old can be irrelevant, let alone if it’s from the prior quarter. Basing decisions on outdated materials will almost always lead to poor choices. 

Using an automated data collector is an easy way to gather up-to-the-minute insights from publicly available data. Once the data is collected, funders can analyze it and make decisions based on their insights.  

If a private equity firm were to attempt its own data collection, I expect it would take one person at least a week to gather what an automated service could gather in minutes or hours. Compared to hiring a full-time data scientist to do the data collecting, online data collection providers are a much cheaper and cost-efficient option. In fact, for $10-$20, these providers can usually get the same amount of work done that a human would a week to do. 

And when it comes to a provider, I would verify they follow a well-defined ethical and compliance code to maintain a secure and reliable data collection network that abides by every regulation. When it comes to a data collection operation, even when focusing on publicly available data, looking “behind the scenes” is just as essential as the data collected – you simply don’t want to unnecessarily put your business at risk. 

After a tumultuous year, private equity and hedge funds are expected to come back stronger than ever. It therefore makes sense for investors to use every resource they have to gain an increased competitive edge in their investment strategies and to make smarter deals. Alternative data provides dependable information that can eliminate uncertainty and aid in reaching intelligent decision-making faster. Using an automated data collector is a hassle-free way for firms to collect this data, so all that’s left is for funders to analyze it with accuracy. As 2021 begins, hedge funds and private equity firms can feel rest assured that external data sources will shed a bright light on closing deals and selecting organizations to back financially.  

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