The COVID-19 pandemic period has prompted huge numbers of people to foray into the world of investments for the first time through a combination of spare time, spare cash (for many) and the proliferation of apps which “gamify” investing. Market highs and the rocket powered rise of certain “story stocks” and cryptocurrencies haven’t hurt either. Everyone wants a piece of the action, it seems.
The rise of retail investors dovetails with another hugely important theme in the investment management space: alternative data sources. Investors are no longer confining themselves to conventional analyses. They are looking at news feeds, product reviews, web activity, social media, internet forums and more to help them pick investments. In fact, 54% of mass-affluent investors today believe that alternative data sources are helpful in managing portfolios[i].
The rationale is clear. Transparency levels and speed of information transmission are so high now that it is difficult to know anything the rest of the market does not. News of a profit warning, for instance, will travel around the world in the blink of an eye. Investors seeking an edge are therefore digging deeper into the global datasphere, which is expanding at a mind-boggling rate. With over 5 billion consumers (and rising) interacting with data every single day, it will have expanded from 23 zettabytes in 2017 to 175ZB by 2025[ii].
Taking cues from meta-data is of course nothing new for alpha-hungry hedge funds. These early innovators in the alternative data space have long been doing things like using satellite imagery to analyse footfall to supermarkets or keeping their ear to the ground to know what people are searching for online. Now, these kinds of analyses are mainstream at all kinds of investment management firms and even among keen amateurs.
Over the pandemic period, we’ve seen just how much power alternative data has to move markets. A certain Mr Musk can make (or break) fortunes with one tweet to his legions of followers, to the extent of attracting the attention of regulators. And he is just one of scores of uber-influencers whose every post is awaited with bated breath.
The GameStop/Reddit affair also demonstrated how easily ordinary folk can influence share prices, and wage war on hedge funds by pumping up the value of the companies they have short positions in. The “power to the people” narrative was naturally very seductive here, although I suspect more fun was had than actual profits for most.
The fun factor
Fun is actually a very important element in all of this. Relatively few DIY investors will have the time, patience and knowledge to wade through company accounts and projections to get a sense of whether Company X is a better prospect than Company Y. When the “chatter” has been shown to affect share prices so powerfully (at least in the short term), who wouldn’t rather take a tour of Twitter to inform their decision?
Yet at the risk of sounding like a luddite, I would urge extreme caution here. For many years, it has been noted that the share price of Warren Buffet’s holding company Berkshire Hathaway gets a boost whenever the actress Anne Hathaway is in the news – such as when she won an Oscar back in 2013. Algorithms may be great at picking up patterns, but they aren’t necessarily so good at understanding their true significance in context.
Enrich, but don't rely
Technology is developing at a stunning pace, however. Aided through Natural Language Processing, AI has the potential to be infallible in reading the runes of meta-data. In fact, last month saw the launch of an Exchange-Traded Fund based on an index where stocks are included entirely on the basis of social media sentiment[iii]. That’s about as zeitgeisty as it gets, but we’ll have to wait to see if money actually gets made.
Research indicates that four in 10 investors don’t think they are equipped with the data and content they need to help them make investment decisions[iv], so far be it from me to disparage them getting insights from wherever makes sense. I would just be very careful to weigh up alternative data in a broader context that takes in all the less sexy stuff too.
A solid investment strategy must be built on a solid understanding of the investments you are getting into. By all means enrich your decision-making process with alternative data sources, but be careful about relying entirely on them. Don’t forget the Hathaway effect.
This piece is for informational purposes only, and is not intended in any way as financial planning or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.
[i] “Redefining Investor Data Needs”, Refinitiv 2021
[ii] Seagate US
[iii] Van Eck’s Social Sentiment ETF, which tracks the BUZZ NextGen AI US Sentiment Leaders Index
[iv] Ibid. Refinitiv