Standardisation of alt data brings promise and pitfalls

Alt data has given the finance industry access to real-time data wealth that would have been unheard of even 10 years ago.

But the clear alpha-generating benefits of this new eco-system have brought new ethics and privacy responsibilities for traders.

Alt data is best described as unconventional, non-market and non-traditional economic and financial information, such as satellite imagery, retail traffic figures, car insurance policy take-up rates, shipping numbers, social media trends and weather patterns.

Alt-data goes mainstream

Today, even the most fundamental, long-only mutual fund managers are basing their decision-making on alt data – even if it is to confirm their ‘gut work’.

The FISD Alternative Data Council states that: “About 50% of investment managers are currently using some form of alternative data, with another quarter planning to start incorporating alternative data in the next 12 months.”

Refinitiv, the American-British global provider of financial market data, believes the use is even higher.

In a recent global artificial intelligence/machine learning (AI/ML) survey it conducted of the top financial institutions using AI/ML today, it found that 70% of firms are using alt data. It stated: “The US leads the way with 97% adoption. Adoption in Europe (67%) and Asia (53%) is further behind but continues to increase.”

Alt data goes from nice-to-have to need-to-have

How alt data is used will depend on a firm’s approach.

Fundamental managers are more likely to glean insights from alternative data to validate signals produced by their more traditional models.

For quantitative managers, the approach is from the other end. They use alternative data as an input into an algorithm that shape their investment thesis.

However, if alt data is ‘out there’, it’s not always accessible.One of the biggest challenges for its adoption is making it data usable because it has to be validated, structured, and linked before it can be usefully analysed.

In a recent study conducted by Greenwich Associates, 62% of respondents said they wanted their data “pre-packaged and structured” to make it more easily consumable.

Increasingly, third-party providers are delivering just this. Established data providers such as Dun & Bradstreet and Dow Jones now package their non-traditional data sets into consumable data products that can be integrated seamlessly into investment firms’ internal systems.

Their value is being seen as ever more vital, as the LSE’s recent $27bn purchase of data company Refinitiv illustrates.

The deal is expected to allow the LSE to maximise demand for computer-driven trading and put it in head to head with Bloomberg, the US powerhouse.

And the alternative data industry is continuing to grow. According to Grand View Research, in 2020, the industry was valued at $1.72 billion and, by 2028, is expected to reach close to $70 billion.

Regulatory scrutiny eyes alt data

Regulators, however, are also increasing their interest in the ‘fair use’ of alternative data. Its potential informational advantage clearly raises issues regarding propriety, privacy, fairness, and ethics.

In the UK, the FCA is considering whether alternative data could introduce new risks to market integrity.

The EU’s General Data Protection Regulation (GDPR) is one barrier to use, having introduced big financial penalties for transgressors.

In the EU, the key financial services measures likely to be relevant to the use of alternative data are the Market Abuse Regulation (MAR) and the Markets in Financial Instruments Directive (MiFID).

In the US, the SEC took a significant step in September 2021. It brought the first enforcement action against an alternative data provider for securities fraud.

App Annie, Inc. was forced to accept a cease-and-desist order for misrepresentations both to data sources in connection with the collection of data, and to investment firm subscribers regarding the data underlying its product.

The question that should now be forefront on any firm’s mind is this.

Can alt-data violate insider-trading regulations?

The short answer is – yes, but not usually – but getting it wrong may well not be a risk worth taking.

For hedge fund managers, being wary of the optics of ‘exclusive’ alt-data sets may be a sensible path ahead.

Regulations and accepted practices governing the use of alt data are still in the early stages of maturity. It remains, nonetheless, incumbent on IM firms to manage their risks to protect their assets.