Data scraped from smartphone apps and social media feeds has been promoted as a means to identify investing opportunities and tap into alpha. But institutional investors may be better off focusing their data resources elsewhere, at least according to a new research paper from Stanford University’s Global Projects Center.
The paper, “Rethinking Alternative Data in Institutional Investment,” suggests that asset allocators such as pensions, endowments, and sovereign wealth funds benefit most from using new data sources to support functions like risk management and operations, rather than the “exploitative” strategies pursued by hedge funds and other asset managers.
Stanford’s Ashby Monk, Marcel Prins of APG Asset Management and Dane Rook of Stanford said in the paper that such “alpha-oriented, opportunistic” strategies tend to require speedy execution, which most allocators do not have the agility or risk appetite to successfully undertake. What these investors do have, however, are long operating horizons, which give them the ability to be “more methodical and disciplined” than shorter-term investors.
“This comparative advantage is more aligned with defensive and defensible approaches to alt-data than it is with the exploitative strategies that short-horizon investors tend to pursue,” the authors explained.
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One example of these “defensive and defensible approaches” is incorporating alternative data into the due diligence process. An allocator could, for instance, use data derived from LinkedIn to determine the strength of a venture capital manager’s professional network.
Another potential function of alternative data is using it to identify and eliminate internal inefficiencies, improving net returns by cutting extraneous costs. Most investors “already possess large volumes” of alternative data that could be used for this purpose, according to the paper.
“Inventive collation and synthesis of documents, such as emails, investment memos, and contracts, can uncover precious metadata that is able to provide insights for enhancing communication, culture, negotiation, time allocation, benchmarking, and diligence,” the authors explained.
Such in-house data could be supplemented with data sets from alternative data vendors. Investors could also get indirect access to data insights through asset managers, although Monk, Prins, and Rook warned that investors shouldn’t rely on them entirely. In today’s “alt-data arms race,” allocators need to develop their own data capabilities to remain competitive.
“Investors are unlikely to remain unaffected by alternative data,” the authors wrote. “Potential opportunities afforded by defensive and defensible alt-data strategies give investors ample reasons to not only seek access to alt-datasets but build internal capacity for working with and acting on them. Cultivating such capacity could be a key engine for innovation.”