Alternative Data in Investment Management: Usage, Challenges, and Valuation

Alternative data in finance is an umbrella term for diverse non-traditional datasets used by quantitative and fundamental institutional investors to enhance portfolio returns. While the use of alternative data is a recent phenomenon, it was not until the last five years that it gained widespread acceptance and the sector had evolved into a complex ecosystem of data originators, intermediaries and investors. The alternative data industry faces several obstacles, including difficulty estimating a dataset’s potential value to investors and technical challenges for leveraging these datasets efficiently at large scale. In this article, we provide an up-to-date description of the alternative data space as it relates to the institutional investment industry. We elaborate on what alternative data is and how it is used in investment management today. We identify and discuss some of the key challenges that arise when working with alternative data. In particular, we address issues such as entity mapping and ticker-tagging, panel stabilization and debiasing with modern statistical and machine learning approaches. We advance several methodologies for the valuation of alt-datasets, including an event study methodology we refer to as the Golden Triangle, the application of report cards, and the relationship between the structure of its information content and potential to enhance investment returns. To illustrate the effectiveness of the methods, we apply them to a case study analysis of real-world healthcare data, delivering an improvement of revenue prediction accuracy from an 88% mean absolute error to a 2.6% mean absolute error.