When it comes to making investment decisions, alternative data comes with both its risks and promises. Nonetheless, when it comes to making decisions, alternative data plays a crucial role in investment management. In fact, in this modern era where data governs all, investors would be at a loss, lacking the necessary data and information required to make the right decisions.
Why alternative data is important?
The key to making progress in the financial market is to make the right decisions. The only difference between an investor and their competitors is the decisions made. And while experience plays a part, in today’s world, the fundamental pre-requisite of making a good decision is to be data-informed.
Alternative data is a way to keep yourself well-informed. Investors who are not ready to stay up-to-date and re-evaluate their investment process in new ways are likely to be overrun by competitors. Alternative data is a growing trend that has proven its worth time and again, rising in necessity.
In fact, the alternative data market size is predicted to reach USD$11.1 billion and is projected to rise at 44%. This fact alone is enough to highlight the importance of alternative data in today’s world.
Impact of alternative data on investment decisions
Information is the name of the game when it comes to modern-day investing. Alternative data can help provide more information that assists investment managers to take more calculated risks. It helps provide information from non-traditional sources, which in turn provides new opportunities and insights. Investment firms optimize their risk-taking strategy through the use of alternative data.
A simple example of how alternative data can help make better financial decisions is using data like the weather forecast to assess how well a crop can yield and its impact on a certain company in the food industry.
Many firms are using a mix of data, integrating alternative data with traditional. By fusing these two together, investment companies can optimize their portfolio for higher returns. This hybrid model is trending in the modern financial industry and being adopted by many investment firms. This helps in faster-informed decisions and hence achieving alpha.
Risks and challenges
However, there are still a few challenges and risks involved. Three of the major issues the financial industry faces in adopting alternative data are as follows:
- Regulatory risks — Since alternative data in investment is still in its early stages, there is a significant regulatory risk. When using such a large amount of data may cause a compliance issue with the regulatory bodies.
- Talent risk — Alternative data requires a set of specific levels of expertise in data science and financial analytical skills. This is rather an emerging field, so finding the right talent for this job can be challenging. Furthermore, the right technology to process alternative data plays a crucial role in the successful use of alternative data. Alternative data may possess a greater risk than traditional data if there is a concern of data accuracy and validity.
- Model risk — Investment managers may struggle to find the right investment model using alternative data. Although there is a significant technological advancement in AI and machine learning, there is still a large risk when it comes to depending on this for massive financial investments.
- Reliability of the data — Collecting reliable data takes a lot of hard work. The data is often incomplete and unverifiable. Most investment companies don’t have the capacity to source this data themselves. They rely on the data provided by third-party vendors. This leaves room for error, as inadequate data sets can actually prove lethal to an investment decision.
The future of alternative data
Investors can aim to mitigate these risks by using alternative data vendors and relying on data-driven companies like Chain of Demand to make data easier. Despite all the risks involved, overall, the future of alternative data in the financial industry looks promising.
According to the TABB Group, the spending on alternative data in the finance industry may double in the next five years. Its success largely depends on the quality and availability of the data to the investment industry. To get the most out of this space, investment managers need to justify their investment in alternative data through better returns.
Having processed over 100 million data points in the last few years, Chain of Demand’s data coverage is large and expansive. We help provide data the way you need it, making the entire process of handling data easy.