Alternative data, such as social media activity or satellite imagery, has become a big deal in the trading world, with hedge funds and other asset managers striving to find new ways to gain a competitive edge over their rivals.

The belief in utilizing alternative data is that the richness of the data sources will provide a better understanding of the factors that affect assets, but given the intensity of the market, it is increasingly difficult for traders to find something that no others have.

A new study from Rotman suggests that despite the very different skillset required to fully capitalize on the possibilities presented by alternative data, it is possible for hedge funds and alternative data marketplaces to thrive alongside one another.

No threat

“The idea that alternative data could be a threat to the hedge fund industry may overlook the complementary roles between the alternative data vendors and alternative data buyers, where hedge funds play a dominant role,” the researchers say.

“In our paper, the population of skilled investors and the data sellers’ profit always move in the same direction in response to changes in related external factors such as costs and skill volatility, which suggests the two industries foster each other.” 

The researchers developed a model to chart the interactions between data sellers and buyers.  The model took into account the skills required to make sense of the data and showed that the presence of alternative data encouraged investment firms to bring in more employees with data skills.  This, in turn, boosts the performance of the funds.

While this can indeed be expensive to do in the short-term, it is beneficial in the long-term as data sellers were then able to provide firms with bigger data samples, which in turn allowed firms to infer more accurately the future prospects of the assets under consideration.

After the initial investment has been made, the researchers argue that firms then have the capacity to not only process more alternative data, but to do so more cheaply over time, which allows them to process greater quantities of data.  Indeed, in time, what once was considered alternative data simply becomes a standard source of information.