The rise of alternative data, and the exponential growth of new datasets, continues to influence the decision-making process for hedge funds and other asset managers across the investment spectrum.
The rise of alternative data, and the exponential growth of new datasets, continues to influence the decision-making process for hedge funds and other asset managers across the investment spectrum.
While the ongoing expansion and evolution of alternative datasets can help hedge funds and investors uncover detailed information and insights ahead of a company’s initial public offering, how they ultimately use that data remains critical to the success or failure of an investment idea.
For Ed Lavery, Director of Investor Solutions at web analytics provider Similarweb, alternative data sources not only help investors understand a company in isolation – but also, crucially, how the company is growing in relation to its market and competitors.
“Many of these businesses that are IPOing at the moment are growing on the premise that their market share is increasing, and that they have a sustainable customer base, and good retention of customers,” New York-based Lavery says
“But most of this kind of information is not usually reported in company prospectuses. In general, there is very little information out there on pre-public companies. When they IPO, the information provided in their S-1s is also very minimal.”
Similarweb has a particular focus on website data and browser traffic. Such data provides both a rear-view perspective on a company’s track record, while simultaneously identifying future trends, which in turn can potentially map the forward performance of a business, he says.
Mentality shift
“What you’re not doing is directly tracking the financial performance of a company. What you are looking for are trends within a business rather than the actual performance. You’re tracking customer behaviour – which is a very different way of looking at businesses – and trying to translate that into a financial signal with which you can value that company,” Lavery explains.
“This is something of a mentality shift for asset managers. It’s a lot less black and white, and it’s significantly more nuanced which can often make it harder for asset managers, I believe, to really find and realise where all the value is in a dataset.”
Expanding on this point, Lavery says one sizable challenge for data vendors is how to create something which is easy for investors or asset managers to use and digest – “in a way almost spoon-feeding them the data they need to look at” – while at the same time offering them something that offers enough flexibility to explore and manipulate data to help the alpha-generation process.
“Some customers want something very spoon-fed. Then there are others, the more sophisticated funds, who want something super-flexible that they can find the right alpha on, and explore it themselves,” he says. “A good data vendor generally will offer both options.”
For Similarweb, the key metric is website data, which helps investors gauge not only the digital reach of a company, but with engagement tracking, conversion numbers, and subscription and log-in stats, supports a better understanding of potential inflection points of a business.
“Website traffic ultimately offers a top-level view of what’s going on within a business, and how it may fare in the future,” he notes.
“Engagement proxies can be used almost as predictors of what the company might be doing in the future. For an e-commerce website, for instance, you want to see customers spending longer on the site, and the average duration, going up over time.”
He continues: “Web traffic can also help examine marketing trends, so you can see the amount of traffic coming from a paid search or even PPC cost. This is actually a critical metric to look at in a pre-IPO company, because companies will often pay a lot of money to boost their traffic just ahead of an IPO so it appears as if it is performing better than it actually is. It helps you understand how organic this traffic is.”
Building confidence
Reflecting on the avalanche of new alternative data over the past few years, and its far-reaching impact on the investment management industry, Lavery believes there is a need among some managers to “open their minds” to the kinds of questions that may be asked of data.
“It’s definitely becoming much more mainstream,” he observes. “But I think the whole industry often overcomplicates it – they make it sound much scarier than it actually is. In its simplest form, data is just information that managers can use to make a decision.
“There’s an assumption that you need to be a really smart data scientist or analyst to clean the data to establish a signal and then forecast what a company is going to do. That’s quite an antiquated way of thinking.”
Underlining this point, Lavery suggests that those managers and investors who can get the most value out of datasets are the ones who can build a robust interrogation process, zeroing in on different questions and building hypotheses on a company beyond its simple financial statements.
“Data does not give the answers,” Lavery observes of the interrogation process. “You need to ask questions of the data, and it will either validate the question or contradict it.”
He adds: “Generally speaking, there are two main use cases for alternative data for hedge funds. One – does a dataset provide conviction to my hypothesis on a company? And two – does it signal a new idea, or a new inflection point for a company that I wasn’t aware of before?
“I think for hedge funds and asset managers, it’s about finding a dataset that can provide greater strength to a hypothesis that they have for both long and short term investment decisions. It may not provide them with the exact answer, but if it’s something that provides them with greater confidence when they’re making a decision or a call, then there’s a lot of value in that.”
