Hedge funds are spending hundreds of millions of dollars annually to acquire alternative data — and most predict those expenses to keep rising, according to research by law firm Lowenstein Sandler.
More than four-out-five hedge funds polled said they currently use non-traditional data sets in some capacity, for example in assessing potential investments or in internal risk management. Among users, 55 percent reported spending an average of six figures annually on alternative data. More than a third spent upwards of $1 million.
Lowenstein Sandler reported that 81 percent of hedge funds planned to increase their alternative data budgets in 2019, with the largest proportion — 46 percent — projecting a budget increase between 11 percent and 25 percent.
The majority of hedge funds (68 percent) get their data through in-house processes and by purchasing it from vendors. Large hedge funds — those with more than $5 billion in assets — were most likely to rely on both acquisition methods, while sub-$500 million funds were the most likely to solely DIY.
[II Deep Dive: Is Big Data Too Popular for its Own Good?]
Non-traditional data sets, ranging from consumer transactions to social media and app data, are being used in almost all aspects of the hedge fund business, according to the survey. They can generate market insights, support fundamental research, help managers understand competitive markets, and develop “unique” investment strategies, surveyed hedge funds said. Other common uses included predicting volatility, profit and risk-adjusted return generation, improving business operations, and client retention and attraction.
Despite the pervasive use of alternative data, surveyed funds reported a number of concerns, primarily related to cost and quality. Other worries included possible data security and privacy issues and the risk of acquiring material nonpublic information. About a third of survey respondents reported a shortage of staff with the skills needed to handle and analyze alternative data sets, while 21 percent worried about the higher compliance burden.
All of the hedge funds surveyed believed their data strategies had room for improvement. About 44 percent felt that their strategy could be improved “somewhat” through better monitoring and quantification of risk, while 29 percent said their strategy could use “a considerable amount” of improvement and 19 percent said they could improve “a great deal.”
“If plans continue to invest in alternative data, it will be vital for them to have a solid strategy, an effective process to evaluate their sources, and the correct staffing,” the law firm concluded.