Alternative data is poised to transform private equity. The use of non-traditional, non-financial and externally originating data sets can fundamentally change how buyout firms screen and execute investments, manage their portfolio companies and time their exit. That is contingent, however, on PE managers overcoming the technical and regulatory barriers to emulating their hedge fund counterparts in terms of alt-data adoption.
Broadly speaking, the diverse potential applications of alternative data for private equity firms can be divided up into different stages of the investment lifecycle.
At the asset selection and due diligence phase, web crawling and satellite or drone imagery can provide valuable insights into the performance of target companies and their competitors, particularly in retail or other consumer-focused businesses.
Likewise, in B2C-focused companies, the use of search engine, social media and mobility data can provide a valuable window into customer sentiment and brand perception. And across both B2B and B2C businesses, comparable data tracking employee sentiment (of either the target company or its peers) can point to attrition rates and hiring trends – particularly important indicators of future performance for asset-light, service-led businesses.
In terms of portfolio management and operational support, PE firms can leverage alt-data to help their investee companies improve complex supply chain management processes – a particularly pressing concern in this age of rising geopolitical barriers and rampant inflation. Customer data to help in predicting future demand, shipping data to detect disruptions, the internet of things and geolocation to track physical goods or cargo flight data to track end-to-end status on shipments: the sources are voluminous.
Finally, when projecting value creation and calculating the optimal timeframe for exit, the identification of new technology and patent trends that may bolster the sector provides an important reference point. PE investors can better predict the future direction of the business and its sector and thereby maximise value. By positioning the company in a different, more highly valued vertical and marketing it to a different universe of buyers based on its future strategic direction, the sponsor can benefit from multiple arbitrage, driving financial returns irrespective of earnings growth during their hold period.
These use cases apply to the entire investment lifecycle of the asset class as it currently exists: strategy formulation, asset selection, deal execution, portfolio management and investment realisation. However, the reality is that there remains significant runway for alt-data adoption in private equity. The majority of managers, while aware of the need to digitise their processes, primarily use some sophisticated data analytics in the middle and back office, but not yet even as a CRM tool for the deal team.
By the time we see widespread adoption of alt data in PE firms’ front offices, therefore, the asset class may have undergone significant evolution. The applications of alt data will also need to encompass the market niches and investment strategies that managers will favour in the decades to come. Happily, alt data is almost purpose-built to help demystify one of the biggest and least understood new opportunity sets for alternative asset managers: digital assets.
Some of the biggest names in venture capital have thrown their weight behind crypto as an asset class, helping spur its growing institutional adoption. Andreessen Horowitz, best known for its early-stage investments in present-day household names including Facebook, Twitter, Lyft, Pinterest and Slack, last year closed its third dedicated crypto fund with $2.2bn in capital commitments. In April the firm also announced the launch of its own crypto lab. And its blue-chip VC rival Sequoia Capital launched a $500m crypto-focused fund of its own earlier this year.
Meanwhile, the biggest crypto platforms have set up their own dedicated investment arms to deploy capital into new blockchain-based ecosystems and other digital assets. FTX Ventures, Coinbase Ventures and Binance Labs have all emerged as challengers to alternative asset managers’ crypto strategies. This development is equivalent to how the corporate venture arms of tech giants like Google, Salesforce, Intel and
Baidu have established themselves as a deep-pocketed category of VC investor that rivals traditional financial sponsors when it comes to backing early-stage high-growth tech businesses.
What all this suggests is that the venture capital landscape will progressively skew more and more towards investing in digital assets. The most pioneering and tech-focused buyout funds will, in all likelihood, follow soon after.
Of course, the discourse around the asset class is currently negative. Even the mainstream business news agenda has lately been dominated by the widespread downturn in crypto valuations, as well as the blow-up of Luna and its algorithmic stablecoin counterpart TerraUSD specifically. But if we acknowledge the long-term secular trend towards greater institutional adoption of digital assets, these periods of significant volatility only underline the importance of using alt-data to model and better predict asset valuations.
For digital assets, what we currently call “alternative” data sets actually provide perhaps the best insight into some of the fundamental drivers of valuation. Social sentiment monitoring allows investors to track buy and sell signals coming from influencers and “whales”, helping to anticipate price moves that have historically been considered completely inscrutable. Likewise mining stats, the crypto equivalent to point-of-sale data, tracks new blocks added to a blockchain and can help indicate trading volume, demand and circulation. For Non-Fungible Token (NFT) transactions, tracking individual tokens’ uniqueness scores against their pricing allows for the identification of undervalued NFTs.
The potential applications of alternative data for private equity and alternative asset investors are manifold. They extend from improving the existing and well-worn processes of the most mature parts of the asset class – namely, investing in and growing companies – to helping to demystify the fast-growing universe of digital assets, which represents the next frontier for the most progressive and tech-led PE-style investors.
Yamelin Castillo is head of wealth & asset management at New York-based tech consulting firm Lab49.