When it comes to making smart investing decisions, data is king. And in an investing landscape where every trader has cheap access to core financial data, a trader with access to a unique dataset that is not widely available to the public can act on this powerful information to generate alpha. These alpha-generating undiscovered data assets are called alternative data – and they’re one of the fastest growing data sources on Wall Street. Hundreds of firms and hedge funds are incorporating alternative datasets into their models in order to derive profit-generating insights
Datasets comprised of satellite imagery, geo-location data, and social media data are just a few of a vast number of alternative data sources that have yet to undergo widespread adoption by the investment community. For example, when JCPenney announced better than expected earnings for Q2 2015, most investors were taken by surprise. A few hedge funds, however, were not surprised due to an obscure dataset of satellite imagery provided by RS metrics, which showed an increase in foot traffic in JCPenney parking lots.
The hedge funds were able to make a 10% profit in two days all thanks to their access to an alternative dataset.
Unlike RS metrics’ satellite imagery data, ESG data is available at no cost to anyone with a Bloomberg terminal.
The growing dataset of environmental, social, and governance (ESG) data is one of these alternative methods that fund managers are turning towards in an effort to generate alpha for investors. Multiple studies have verified that in the long run, companies with sustainable business practices generate higher returns with lower volatility compared to the market as a whole.
The “E” of ESG represents the ‘Environmental’ impact of a company including its carbon emissions, natural capital, renewable energy, and water stress.
Next, the “S” stands for ‘Social’ and pertains to the data surrounding human capital, labor standards, privacy and data security, and stakeholder opposition.
And finally, the “G” is short for ‘Governance’, taking into account data about the board, pay, corruption, and business ethics and fraud.
Recent scandals such as Volkswagen’s violation of the Clean Air Act, Facebook’s data privacy issues with the Cambridge Analytica breach, and Wells Fargo’s account fraud are examples of how Environmental, Social and Governance can present themselves as portfolio risk, respectively. The Volkswagen emissions and cheating scandal, for example, resulted in the stock shedding nearly a quarter of its value.
Why has ESG just recently become a consideration in portfolio construction?
The emergence of quality ESG data sources is largely responsible for facilitating the increased adoption of this alternative data asset. The percentage of corporations in the S&P 500 publishing sustainability reports has risen from just under 20% in 2011 to 85% in 2017. Similarly, across the Atlantic the European Union has mandated companies with over 500 employees to report certain ESG data.
