Joshua Maxey, co-founder, Third Bridge, writes that hedge funds have become highly sophisticated in their use of research and yet face challenges in accessing incisive, differentiated and actionable insights.
Using alternative data or primary research is now as mainstream as the customary, decades-old approach of sifting through company accounts and building quantitative models.
Traditional financial and economic data remain central and always will, as do the personal connections hedge fund analysts establish with company principals. But the days of sell-side research and corporate access dominating calling quarters are no longer. Over the past 15 years, the way that hedge funds research has transformed, as analysts discovered new ways to get ahead of the consensus in search of alpha.
During this time, two new markets took hold. One is the market for alternative data and the other is for primary research.
Alternative data includes everything from credit card swipes to smartphone geolocation data, clickstream data, web scraping and social media sentiment analysis. Primary research, meanwhile, encompasses expert networks, expert interview transcripts, group meetings and surveys. The latter enables investors to hear from people with direct experience of a company or sector – experts with unique and transferable insights derived from proven practical experience.
Back in the nineties, there were just 20 specialist firms operating in these two areas. By the mid-noughties, a decline in sell-side research coupled with the advent of social media and big data put rocket fuel under the alternative data market. Early-adopter hedge funds were out in front making early wins.
By the time Third Bridge launched in 2007, we could see how hungry hedge funds were for unbiased insights and how frustrated managers had become with the limitations of traditional research sources.
A new era of data
But it was in 2010 when alternative data really hit the headlines with CNBC reporting at the time that “Cold War-style satellite surveillance is being used to gather market-moving information”. Advancements in AI and cloud technology were creating a range of new possibilities for generating alpha.
This caused a seismic shift in the research market. By 2020 the number of alternative data providers and primary research companies had exploded – and that was before Covid boosted the market even further by locking down corporate access.
Firms such as Yipit, M Science, Earnest, Similarweb, and Sensor Tower became the key players in the alt data space, while Third Bridge, GLG, AlphaSights, and Guidepoint came to lead the primary research category.
Data limits
There was a time when a channel check meant hiring someone to stand outside a supermarket counting cars. A lot has changed since then. But as sophisticated as the hedge fund research markets have become, a new challenge has arisen as these services have become mainstream. Finding truly differentiated research is increasingly difficult.
The simple fact is everyone is now reading those same YipitData or M Science reports around TMT and consumer names, especially in the US. It’s a category that has become commoditized and oversaturated. The alpha edge has been lost and hedge funds are having to look elsewhere for new signals.
With hedge fund research budgets under pressure, especially in light of recent widespread redemptions, the leading players are now carefully recalibrating their spending. Hedge fund managers are recognising that alternative data sources are not without their problems.
Some feeds are less structured and hard to process without sophisticated IT operations to make this data crunchable and actionable. It remains difficult to access accurate numbers on the energy, industrial and B2B tech spaces, and data that is obtained is often unverifiable.
In the primary research category, where most hedge funds tap at least one expert network provider and all of the biggest players consume interview transcripts, we see some overlap and mismanaged expectations. The hedge fund managers I speak to report that some expert network providers simply can’t identify or access critical experts quickly enough – while the content from certain expert transcript providers is often patchy and repetitive.
Reappraising research approaches
In response, hedge fund managers are innovating in three ways. First, larger hedge funds are returning to their old methods by going direct to companies to gain corporate access once again. This is leaving smaller players to look for ever more niche data sets and market-specific primary research providers. Everyone here is looking to cut costs, maximise speed, and minimise friction. This is causing alt data aggregators to grow in popularity, and there are new specialised start-ups in primary research seemingly every day.
Second, a great deal of emphasis is being placed on research valuation. Here hedge funds are taking a sophisticated approach to benchmarking the quality of research on offer. In practice, this means prioritising the data sources that provide maximum utility and the expert networks and transcript services that reliably deliver industry executives with unique in-depth knowledge week after week. Searchability and UX (user experience) are also important factors they are weighing up.
Third, efficiency has become the name of the game. The market for interview transcripts is growing quickly. This is because transcripts help funds cut through the noise by sourcing unique insights in the shortest possible time. Yet the business intelligence market remains inefficient and could better serve the needs of its clients. Many hedge funds use multiple research sources, but more tools do not always equate to better outcomes. Managers are now consolidating their research spend, seeking out integrated providers that can do it all and proactively support hedge funds throughout their research process.
The easier and faster that managers can gain access to primary insights, the better. The current market is still too fragmented and the stakes are high. This is going to result in further pain for research firms that are unable to join the dots or provide little differentiation.
