The Use of Alternative Data in Hedge Funds Seems Only Set To Increase

The alternative data market is on a tear. According to Grand View Research, a compound growth rate of 53.2% is expected from 2022 to 2030 in the United States, driven by the increase in the types of data that have become available in the past ten years.

Grand View Research says that more than 400 vendors are now active in the market. Credit and debit card transactions, social and sentiment data and web scraped data are set to be the three largest segments in 2030 but collectively, these still make up less than half of the projected market, with website traffic, mobile application data and satellite and weather data also featuring.

Hedge funds are the biggest customer segment. Grand View Research says that 70% of all dollars spent on alternative data in 2021 came from these firms, no doubt fueled by the need to be able to extract alpha from relatively mature, efficient markets.

It’s an interesting space. One challenge facing hedge fund managers examining alternative data is identifying which of these datasets can provide persistent alpha. Excitement about a new discovery can quickly turn to dismay as more investors use a data source and trades become more crowded, leaving a manager with a subscription to an expensive dataset that no longer works as well for them.

However, it’s not all about alpha. Hedge fund managers are increasingly using alternative data as an integral part of their risk management function, sounding the alarm when something might be about to go wrong. After all, a 20% loss requires a 25% gain just to get back to parity – it’s often easier not to lose money than make it.

Tumultuous markets are supposed to favor active investment management strategies, and in the first half of 2022, U.S. large-cap equities declined approximately 20%, whereas the HFRI Equity Hedge, a broad-based index of equity hedge fund strategies, declined by only around half of that, showing that perhaps good old fashioned stock picking should, if not provide opportunities, help soften the blow, arguably leading to less of a need for alternative data.

But since the beginning of July, the S&P 500 has been creeping back up, giving investors with beta exposure to public equities some welcome news. And equity hedge fund managers will benefit too, a rising tide lifting all boats. But if equities continue to rise, and alpha becomes more difficult to source, alternative data seems to offer many areas of support.

It’s a fascinating part of the investing world, one that managers with both discretionary and quantitative approaches are embracing. How the next six months pans out remains to be seen, but it seems that regardless, alternative data is set to become a mainstay of the hedge fund industry.

Anthony D. Mascia is Managing Partner at EFSI. Connect with him on LinkedIn here.

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