Despite the challenges of 2020 that shook most investors, the hedge fund industry recorded the best returns over the past ten years, reaching 11.6%. Private equity, on the other hand, had a dip of 7.3% year-on-year. Many analysts are highly optimistic that private equity will recover quickly in 2021.
The main reason is that more and more private equity activities now include alternative data in their analyses, reaching a growth of 21% this year so far. Let’s see how private equity utilizes alternative data to improve portfolio returns and why more and more companies start to incorporate these data into their day-to-day management and decision-making processes.
Making better decisions with increased certainty
Essentially, alternative data refers to public information that does not come from traditional sources, such as social media activity. All types of data can be used to have a better insight into a company’s prospects and business strategy.
Private equity firms are involved in a broad array of deals, many of them being large-scale. As a result, any informational advantage achieved using alternative data can strengthen certainty regarding particular companies. This is one of the dominant private equity trends nowadays.
For example, Thasos Group is a database company that informed its hedge funds clients that Tesla was working on boosting one of their car’s production. This led to a stock increase of 9.1% after they released the quarterly performance. The database company knew this because they used mobile phone location signals at the company’s headquarters. This information revealed a 30% rise in overnight shifts, so they concluded that Tesla was working on boosting the production capacity.
Ideal for both quantitative and fundamental analyses
One of the best highlights of alternative data is that it comes in all types of forms – whether it is numerical or qualitative. For instance, private equity can use both information collected from social media posts or look into buying or selling patterns.
In other words, alternative data can be used by private equity to have a better, more detailed snapshot of a company’s performance. Quantitative data can provide an in-depth look into patterns, trends, and behaviors over time. On the other hand, fundamental analysts can access information for a quick understanding of the current market.
One particularly successful case is related to a hedge fund known as Sender Company & Painters. Using alternative data, this hedge fund obtained 30% returns simply by using real-time information regarding Robinhood users, particularly their buying and selling behaviors. This indicates that companies using alternative data can successfully improve their financial outlook, regardless of the investment strategies.
Understanding the market trends and the general direction
Alternative data are incredibly varied – where it is about transactions, how often people use cash, foot traffic, and more. Private equity uses this data to understand the general market direction better. In other words, all types of qualitative data, such as social media posts, can be used to accompany traditional data, showing PE investors the direction of a specific market.
Alternative data might not suit traditional investment strategies, but they can complement them. For example, a PE investor can look at receipts and transactions to understand whether private firms in a given sector open new facilities, pay rent or purchase the buildings, and more. This can show whether the firm is downsizing, expanding, or other valuable insights.
This becomes even more relevant when private equity firms combine alternative data with traditional data sources. For instance, opening more offices and identifying an increase in job post listings can show you that the firm is expanding. Correlated with growth that’s already there, you can easily assume that the company’s financial performance is on the right track, so you can make the decision easier. In other words, you might not be able to close large deals only using this information, but more knowledge is always a competitive advantage in investment.
Managing existing portfolios or assets
Apart from helping to make an investment decision, private equity investors consume alternative data for risk management purposes. Having access and utilizing alternative data can help you make better predictions about your current assets or even the entire portfolio. Collecting information from non-traditional sources, such as sensors, social media, and others, can help you stay ahead of the competition and control your losses.
Nowadays, information is so abundant that there are numerous ways private equity can utilize it to improve performance. These data do not replace traditional investment strategies; rather, it is a way of supplementing the information to improve the decision-making process’s quality. It is used to identify growth and investment opportunities, manage risks, and assess the overall market direction. In short, private equity investors who will fail to include alternative data in their activity will shortly be outperformed by competitors due to informational advantage.