Unexpected Alpha

Big data is big business, but what about its alternative friend? 

While many will be familiar with traditional forms of data, such as corporate earnings reports, market prices and economic indicators, the level of detail and unique nature of the information found in alternative data is becoming increasingly sought after.

Its ability to help investors generate alpha, particularly when looking at nascent areas, has driven an explosion of interest – not just among quantitative hedge funds like Jim Simons’ Renaissance Technologies, but at the retail level too.

Chris Camillo, CEO of social data intelligence provider TickerTags, has found from his work advising institutions that a social arbitrage strategy lends itself better to individual investors. “It's not about having a financial pedigree or being a better financial analyst than someone else, it's really mostly about your ability to surface off the radar information early,” he tells Opto. 

The process of extracting information from places like Twitter or Reddit to then determine a meaningful change — in sentiment or demand — is not something that Wall Street investors are particularly accustomed to doing after all. It requires a large degree of intuition and interpretation, which Camillo believes is more suited to retail investors, who have more flexibility. 

“It's not about having a financial pedigree or being a better financial analyst than someone else, it's really mostly about your ability to surface off the radar information early” - Chris Camillo, CEO of social data intelligence provider TickerTags

 

Indeed, sophisticated software is not necessary to spot a trend in the market either. Camillo was able to find an investment opportunity in Hewlett-Packard [HPQ] from simply identifying that people were having trouble buying printers and ink amid the work-from-home trend. Through observational awareness, he was able to determine that there would be a second spike in demand, which not even the company itself had expected. 

 

Tools of the trades

The most popular sources of alternative data come from web scraping, satellite and aerial surveillance, card transactions and social media. Transactional data, in particular, Camillo says, has been the go-to data set among institutional investors for the past five to six years.

It’s easy to understand why, too, when considering that transactional data gives investors valuable insights into consumer spending behaviour. For example, the Alternative Investment Management Association (AIMA) found a hedge fund manager working in the credit space was able to help with the risk mitigation of high-risk borrowers by identifying missed payments through bank ledgers.

Camillo, however, believes that social media data (also described as conversational data) is superior to transactional data due to it being more qualitative in nature. It often forms the basis of a narrative, which is what he uses to determine an investment thesis. After that, Camillo explains that he’ll use other sources of alternative data to then confirm his thinking. “As someone who [arbitrages] social data or conversational data, you have an opportunity to at least get a leg up on institutions that are relying on transactional data,” he explains.  

“The underlying principle of social arbitrage is information imbalances, meaning there's information you're able to detect that has not yet been fully recognised or appreciated by the market,” he says, adding that it could be as simple as a shift in consumer culture or behaviour, or even a new brand trending. 

“The underlying principle of social arbitrage is information imbalances, meaning there's information you're able to detect that has not yet been fully recognised or appreciated by the market” - Chris Camillo

 

Spotting a slimy trend

It comes down to interpretation and how quickly you can connect the dots. One of Camillo’s favourite trades was when he discovered a trend of children making slime at home. 

While there wasn’t a pure-play slime company he could invest in, he found that white glue was the main ingredient, which was predominantly controlled by Elmer’s. Camillo promptly made an investment in the business’ parent company (Newell Brands [NWL]), which, sure enough, saw its revenue spike 50%, despite it only making up 1–2% of its total revenue. Camillo made 200% on the leveraged trade.

As a concept, the idea of spotting interesting patterns in consumer behaviour in unconventional places is nothing new. In fact, it’s something Camillo has been doing since he was a kid. 

It started with just noticing that his favourite drink at the time — Snapple Lemon Tea — was being understocked at his local newsagent. After talking with the manager, he was able to distil that larger beverage companies were stealing shelf space. 

The parent company of the drink at the time had not made any mention of this in its earnings release and so he asked his brother, who was a stockbroker, if there was a way to take advantage of this information, which sure enough led to him taking a short position on the stock, which returned a tidy profit.

“Even as a young child, I realised that I was able to detect change quicker than institutional traders and that I could do well in the market,” he says. While there is no way to measure the exact direct return on investment that alternative data can offer, Camillo has managed a 68.4% average annual compounded return between early 2007 and 2020, according to an audit in Unknown Market Wizards.  

“Even as a young child, I realised that I was able to detect change quicker than institutional traders and that I could do well in the market” - Chris Camillo

 

The information age

Tom Kehoe, managing director at AIMA, has noticed growing interest not only from the broader investment industry but also from governments, central banks and other sectors since the start of the coronavirus pandemic. He also highlighted that there has been a recent spurt in spending, which he doesn’t expect to change over the next couple of years.

Those wanting to get involved won’t be left wanting for information. In 2016, IBM stated that 90% of the world’s data had been created in the past two years. Five years later and that has since been eclipsed by projections that suggest 463 exabytes (one exabyte is equivalent to one billion gigabytes) of data will be created a day by 2025, according to Raconteur.

Such a boom of information has driven a proliferation in data science. The AIMA found the number of data providers grew from just 20 in 1990 to more than 400 in 2018. Although hedge funds and asset managers have been increasingly building out their internal data teams in recent years, a Bank of America survey in August 2020 found that only 45% of the industry is seen to be using it in their research, according to TheInstitutional Investor.

In a world where information is becoming outdated before even getting published, the draw to search for clues in real-time is becoming a highly desired practice among investors. As more retail investors join the fray, those looking for hidden gems would do well to keep an open-mind.

 

This article was originally published in our Opto Magazine. You can purchase copies on our Opto Shop.