The hedge-fund manager didn’t invest much in oil, but a data company’s unusual pitch caught his eye.
The firm claimed to pinpoint in real time which oil rigs in Texas were operating — information that could be used, for a price, to make better bets on the commodity.
How did the company acquire this type of potentially extremely lucrative data? It paid a guy $50 to drive around and stick sensors on oil rigs.
The hedge-fund manager, who declined to be named, said he immediately passed.
As hedge funds seek out new ways to beat the market, they’re increasingly looking to alternative-data providers that offer insights into companies not found in filings and earnings calls, such as satellite images and credit-card transactions.
But while most data providers operate aboveboard, the cautionary tale is an extreme example of how traders are trying to balance the promise of getting ahead with the need to avoid using illegal information.
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Asset managers, from traditional equity shops to quant funds, have become data managers. As they look further afield for data to give them a trading edge, they’re wading into new, legally risky territory. Some fund managers and industry lawyers are eyeing potential regulations that could reshape how they source and use data.
Last year was one the worst years for hedge funds in 20 years, as prominent investors including John Paulson, Jason Karp, and Dan Och all returned money to investors after closing funds.
As a result, managers — especially in the stock-picking space — are under more pressure than ever to find unique data sets that will give them an edge and justify their fees.
The alternative-data space is exploding.
IBM found in a 2018 report that 90% of alternative data sets available to purchase were created in the past two years, and AlternativeData.org estimates there are more than 410 providers in the industry.
With asset managers collectively spending as much as $3 billion annually on such data, according to JPMorgan, the space is starting to attract more scrutiny.
At the recent Context Summits hedge-fund conference in Miami, the possibility of a crackdown in the alternative-data space was a huge topic of conversation among data companies, lawyers, and money managers.
“It’s inevitable,” Mike Marrale, CEO of the alternative-data provider M Science, said on a panel at the conference. His fear was shared by several hedge-fund managers, who said they expected the Securities and Exchange Commission to bring a case against one or more investors who used data improperly.
The SEC could not be reached for comment about regulation in the alternative-data space.
See more:A growing alternative data company helps hedge funds determine if CEOs are lying using CIA interrogation techniques
Tim Blank, the head of the law firm Dechert’s data privacy and cybersecurity practice, told Business Insider he was watching one pending case about data-scraping from websites that could provide investors more guidance about best practices.
Multibillion-dollar hedge funds with sprawling business often have intensive due-diligence screens for alternative-data providers, but smaller managers hoping to scratch out returns — and keep their business alive — can find themselves playing with fire, managers said.
“If you have a good data set that’s worth money, it is probably being gobbled up by the bigger firms,” said Jordi Visser, the president and chief investment officer of Weiss Multi-Strategy Advisers, which manages $1.7 billion across a hedge fund and a mutual fund.
Emerging managers can then be pushed into obscure data sets without much of a compliance staff to review them, several data providers and small managers said.
‘It’s breaking Excel’
Funds like Steve Cohen’s Point72 Asset Management are dealing with such a massive amount of data that “it’s breaking Excel,” said Kirk McKeown, the head of proprietary research at the $13 billion hedge fund.
John Avery, Fidelity’s head of advanced analytics, said his team at the multitrillion-dollar manager was “overwhelmed by the amount of data coming in.”
Point72 begins its data-collection process by understanding the precise information its investment team needs, rather than by being pitched by data companies, said Matthew Granade, the firm’s chief market intelligence officer.
Once Point72 identifies potential data partners, the firm does a technical review of the data — looking at how far back the data set goes and how specific it is — while reviewing the source of the information by interviewing the provider, Granade told Business Insider, adding that the firm interviewed roughly 1,000 outside data vendors last year.
If a data provider makes it through that phase, Point72 has its investment team trial the data, which can take anywhere from a couple of weeks to “many, many months” based on the complexity of the data, Granade said. If a trial fills the investment team’s needs, a small team of lawyers dedicated to data review combs through it.
“We essentially demand to see every contract in the chain,” Granade said.
At Point72, only a quarter of the providers that make to the trial phase receive a contract.
Hedge-fund managers agreed that the most critical question about data is its provenance: Does the data rightfully belong to the provider to sell?
Managers, portfolio managers, and analysts need to ensure vendors have the rights to license data to an asset manager, that they’ve made their best efforts to anonymize any personal information, and that they’re transparent in answering a buyer’s questions about the data, said Jon Streeter, a Dechert partner who has defended hedge funds and other financial institutions in insider-trading cases brought by the US Attorney’s Office.
Firms thinking through compliance should seek providers that are as invested in following the rules as they are, Tammer Kamel, CEO of the data aggregator Quandl, told Business Insider.
“You want to do business with an organization that has more to lose than you do,” he said.
Quandl, which was acquired by Nasdaq in December, hasn’t seen any suspicious data sellers, but Kamel has seen a range of attitudes about compliance.
“There are some organizations we work with who are extremely pedantic about ensuring that everything is kosher — they ask a lot of questions, they ask for a lot of transparency, and they’re always trying to figure out the ultimate source of a data set,” he said. “There are other funds that are pretty chilled out, for better or for worse.”