As data continues to catalyze evolution in every aspect of the corporate world, financial services firms have begun to deepen their understanding of data and how it can empower their investment models. Hedge funds and quantitative asset managers were first to incorporate alternative data into their analyses, with many newly formed quantitative trading firms now focusing on data as the key input in their models. Private equity firms, on the other hand, have been generally slower to incorporate alternative data, with only 27% of PE firms presently adopting alternative data, and many having no intention to do so in the future. As the data revolution continues, however, PE firms have much to gain from alternative data in all steps of their investment processes.
The key defining feature of private equity firms is an investment mandate focused exclusively on private companies. While public companies have accessible financial statements and earnings reports, comprehensive data on private companies is much more difficult to come by. When conducting diligence and market research, PE firms need access to the most up-to-date, reliable information to inform their investments.
More importantly, PE firms pride themselves on monitoring investments over the course of 5-15 years - a process requiring a dynamic, regularly updated understanding of company activities and market conditions. As such, these investors need data that can be continually refreshed to incorporate the latest available information.
The benefits of alternative data in private equity can be summarized into three categories, encapsulating the entire PE investment process:
PE firms are continually searching for new investment opportunities, evaluating the latest market trends to understand developments in a given industry. Generally, PE investors focus on a diverse spectrum of opportunities and can benefit from outside perspectives. Investors will regularly engage experts in a field to better understand trends, asking questions like: Which companies are most affected by the demise of brick-and-mortar? Who are the biggest players in the retail space? Are companies in this space closing or opening more offices recently?
Alternative data takes these questions and dives deeper, providing concrete insights and analytical takeaways that are updated to reflect objective trends. For instance, SafeGraph’s foot-traffic data on consumer retail operators can answer all of the above questions. Investors can use this aggregated data to understand which sub-sectors are thriving and which are suffering, along with the broader trends of brick-and-mortar retail with regards to storefront closures. The SafeGraph chart below shows an example of such a trend, providing concrete insights into the foot traffic trends at specific department stores over time.
These insights will allow PE firms to meaningfully understand their sectors of interest, enabling them to better decide which industries to pursue and when to do so.
Alternative data enables PE firms to make data-enabled investment decisions. Investments are often driven by recent events - the unveiling of a new product line, expansion into new geographies, or a novel strategic partnership, for instance. Without alternative data, the impact of these events is visible almost exclusively in a company’s financial statements. While these allow investors to understand that the event caused revenue to increase by X% or EBITDA to increase by Y%, there remains a limited understanding of the underlying causes of these changes. Did financial figures improve because of this event, or was it merely a fluke caused by market cyclicality?
Alternative data answers these questions by breaking down events at the most granular level. On the aforementioned example of SafeGraph foot-traffic data, analyses of storefront visits can allow an investor to understand the impact of global events on foot traffic, and whether this foot traffic is sustainable over time. The chart below, for instance, uses SafeGraph data to analyze the impact of COVID-19 on department store foot traffic, showing that some stores like Neiman Marcus and Saks Fifth Avenue were hit especially hard. With this specific data, investors are better equipped to make rational investment decisions and arrive at well-informed valuations.
So, a PE firm closed an investment in a highly promising company. The work required from the investors, however, is nowhere near completion. In order to generate a strong exit down the line, PE investors need to work closely with their portfolio companies to improve operations. This value creation process requires the same type of analysis necessary for effective due diligence - highly detailed, granular information that can guide corporate decisions over time. Much like companies themselves benefit from alternative data sources like Geospatial POI data and Store Visit Attribution data, PE firms can equip their portfolio companies with these same data solutions to improve the success of their investments over time.
A study from AlternativeData.org finds that only 27% of private equity firms currently use alternative data sources in their analyses. This indicates that the industry is awakening to the potential of alternative data, though substantial work remains to be done. As PE firms continue to battle one another in pursuit of the best investments and highest returns, alternative data will be a vital tool in shaping the future of the industry. An asset class once defined by fundamental analysis and qualitative insights, PE now faces its next frontier - incorporating quantitative analysis to make the best investment decisions possible.