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Alternative data in finance holds potentials and risks
Alternative data sources, when verified as reliable and trustworthy, can be an essential tool for financial institutions when it comes to gathering information.
With enhanced competition and an ever-increasing reliance on data, banks and other financial institutions must be adaptable to changes. Poor data quality or a lack of diverse sources of data can lead to poorly informed decisions, hinder business practices and cause bad investments.
With the intention to get a more complete view of customers and investments, companies have sought non-standard data points to get the full picture. This alternative data has become a common port for these organizations and a valuable tool, but it doesn't come without risk.
What is alternative data?
Alternative data is any non-standard data point and is used to provide a more holistic picture of financial health. Instead of relying on traditional pieces of information to inform the decision-making process, financial organizations are seeking other measures that may provide more insight.
"In a consumer scenario, if you are applying for a mortgage, you would typically be judged on whether you would repay a loan based upon your credit score and previous payment history," said Mikkel Hippe Brun, SVP of Asia-Pacific at Tradeshift. "Using alternative data such as income, assets and financial management behaviors, the bank could decide creditworthiness based on a more complete picture of your financial health."
Alternative data is a vast array of information gathered from various sources -- financial transactions, public records, satellites and more -- that goes beyond traditional data sources about an individual, company or industry, such as SEC filings or FICO scores.
In investing, for example, understanding and measuring the economic sensitivity of a specific geographic area to an industry such as oil and gas could be considered alternative data, said Ed Mallon, chief investment officer at Pagaya, a financial technology company.
Alternative data advantages
The desire to use non-traditional sources to provide a potentially more complete picture is nothing new. But, with the spread of COVID-19 and the ensuing widespread stay-at-home orders, the need to gain an advantage has become especially paramount.
"Alternative data, such as transactional, systems and financial data can provide additional, deeper context to allow organizations to more fully understand the behaviors and context around experiences," said Jennifer Passini, senior strategic CX consultant at InMoment, a customer experience platform.
Alternative data can provide details to support root cause analysis and allow for financial and business impact analysis. By increasing the amount of data and applying analytics, financial institutions can position themselves favorably with alternative data and glean insights traditional markers may not be able to provide.
"Alternative data is truly essential to delivering better returns and making smarter investments," Mallon said. "But only if you can analyze it and turn the information into actionable insight."
Alternative data comes with the same demands that traditional data requires: the right technology and the right skills. the right analytics skills, alternative data holds little opportunity for organizations.
It is only with the proper analysis of alternative data that asset management firms and hedge funds can better assess risk and identify low-risk, high-yield opportunities.
Due diligence minimizes risk
The need for collecting information and feedback from users is now a constant, but the how, where and who when it comes to source data will always evolve.
"When quality alternative data sources are identified, these sources can help to not only generate deeper insights, but may also inform the evolution of customer feedback capture," Passini said.
As this capture evolves and financial institutions seek alternative sources and measures, the level of risk is assessed. Standard data gathering is standard for a reason. Tried and tested numerously, organizations often know what to expect when it comes to the reliability and effectiveness.
Straying to the alternative can yield the deeper results it needs to be deeply assessed. If the quality of the source or quality of information is suspect, then the analysis will be useless.
"With any data source, the old adage 'garbage in, garbage out' could not be truer," Passini said. "Before using an alternative data source to provide context or support deeper insights, organizations should evaluate the source for the way it was collected, the completeness of the information and its validity."
Reliability of data sets presents a challenge to financial institutions. Investing time and effort into gathering data from an alternative source that is later proven to be unreliable can set an organization back significantly.
"This is a rapidly evolving market, and due diligence will be key to ensuring the data comes from reliable sources," Brun said. "Other considerations include the security of data, not to mention data privacy concerns and compliance with regulations such as GDPR."