When looking to invest in private equity, data access has always been difficult, especially when compared to public companies. Fortunately, nearly all businesses have now moved some of their activities online, so investors can access data that have never been available before. This is why more and more private equity firms have now incorporated non-traditional data sources in their analyses and investment decision-making process. Let’s see how private equity firms can harness the power of alternative data.
Changes in how private equity works
When it comes to the top private equity trends, it is impossible not to observe the growing importance and impact of technology. For instance, machine learning is becoming more and more powerful when it comes to data analysis. As businesses migrate to the online environment, investors have access to unlimited alternative data in the forms of social media engagements and web-scraped data, among others.
While this may seem beneficial, humans can’t collect and analyze all of this information. As a result, machine learning is a branch of artificial intelligence that employs algorithms to solve this problem, reducing time and labor. The following sections discuss the most crucial alternative data utilization methods that use any type of web-based information that does not come from traditional sources.
When investing in public companies, investors use traditional data to conduct their analysis in order to make a decision. However, when it comes to private equity, access is severely restricted. As a result, alternative data are used to evaluate opportunities, which is mandatory for private equity firms.
Generally, investors must draw on the freshest data available in order to have a better perspective regarding companies. Unlike traditional data, alternative data sources can be accessed to answer a broad range of questions, including which companies are opening more offices or expanding their workforce, which ones are the biggest industry players, and whether brick-and-mortar stores have increased or decreased foot traffic, among others. Essentially, all of these may indicate whether the company is a good investment or not.
For example, accessing foot traffic data can show investors which companies are thriving and which ones were affected by the pandemic or find out which companies had the most store closures in a given period. This deeper insight allows private equity firms to better understand their chosen sectors and decide which industries to invest in, and even find the right timing.
Data-driven investment decisions
Typically, investment decisions are driven by current events, such as a new merger or acquisition, developing a new product, or market expansion. Without alternative data, private equity firms may find out about these strategic movements only by accessing a company’s financial statements.
However, when supplementing this process with alternative data, investors can more accurately understand the main driver behind the event. Some considerations might include how much it changed the financial performance to identify whether changes in performance are driven by market movements, changes in customer preferences, or global events.
Alternative data is employed in investment decisions so you can have a granular understanding of the chosen companies and industries. At the same time, this detailed information can also guide investors’ decisions in the long term by showing which companies are sustainable.
For example, private equity firms can now find out both financial and non-financial information about companies. You can check how a company makes its payments, how many customers visit the physical stores, or even information regarding credit card transactions. This highly detailed information helps you understand if the company is a good addition to your portfolio or not.
Reducing risks and adjusting investment portfolios
Apart from choosing the right assets, investors also utilize alternative data to assess and to mitigate risks. In other words, private equity investors use this granular information to ensure the success of the portfolio in the long run. This is not only related to due diligence but also to competition. Informational advantages can help you easily outperform the market because you have access to detailed data to make well-informed decisions.
Currently, approximately 27% of the private equity firms use alternative data in their analysis. In other words, there is a significant portion of investors who have already recognized the unlimited potential of alternative data. As private equity firms struggle to beat the competition and achieve the highest returns, alternative data are employed in investment decisions to boost the value creation process and improve operations.
All in all, private equity utilizes alternative data to achieve a competitive edge by analyzing information that has not been accessible before. Unlike public investors, private equity firms invest in the long-term, so alternative data can offer invaluable insights to drive investment success. Alternative data can be used to identify investment opportunities, assess risks, and manage the portfolio to make the correct adjustments.