How do you make sense of your data? | Index One
Do you own a comprehensive dataset, but don't know how to make use of it? In this edition of Index One Insights by Index One , we look into how you can make sense of your data to create an index and investable products.
How to make sense of your data? | Index One
A wide range of data is crucial for financial professionals looking to design investment strategies, provide investment advice or simply to make informed decisions on investments.?
The $2.7bn alternative data market is expected to grow by a CAGR of 54.4% from 2022 to 2030 (Grand View Research, 2022). This highlights how data is becoming increasingly important in the financial services industry.
Despite the growth trajectory, major challenges still exist for alternative data vendors. How can vendors convey the value of their dataset in a transparent manner without revealing their proprietary processes behind it, and how can this data be delivered in a usable way for investors?
An index can be used to refine the value of your dataset. By creating an index or investment strategy based on a dataset, alternative data vendors can essentially build a new data product which is ready for licensing or creation of financial products, while maintaining third party validation and transparency throughout the process. In the following article, we will look at the types of data that are available for investors, and how they can be used to build an index.
Types of data for index construction
A money manager could make use of various data to design an investment strategy and offer investment advice to clients. The following list contains the types of data and how they are commonly utilized to create an index.
Historical data:
Historical data are frequently associated with a security's or index's past performance. Historical data allows analysts to attempt to predict future returns or to estimate how a security might react to a specific situation, such as a drop in consumer spending.
Investors and analysts might utilize historical price data to back-test pricing models or investment strategies, to look for historical patterns, or to find technical indicators for day traders, among other things.
How to use historical data for an index: Backtesting
A financial professional can use historical data to backtest a strategy and determine how securities would have performed in certain market conditions. This data can also be used to predict how an investment strategy would perform in the future.
This allows advisors and clients to have a better understanding of how a strategy or a group of stocks would perform, and therefore allows one to make an educated decision on investments.
An index built by a third-party index calculation agent can also be used in marketing materials that aim to display the hypothetical performance of an investment strategy or stock picks.
If an investment strategy is optimized, one can turn the backtested index into investable products that can then be traded on a stock exchange.
Stock ratings:
An analyst or rating agency will give a stock or bond a rating or signals, as a way of evaluating future performance.
Buy-side and sell-side analysts do stock research and offer comments and stock signals on the equities they cover, which frequently include a rating such as "buy," "hold," or "sell."?
How to use stock ratings for an index: Research tool
Stock ratings and signals can be used by equity research analysts and companies to create an index that can be used to convey the value of their equity ratings. Building an index based on stock ratings can be used to offer clients with a clear representation of buy, hold or sell directions.
An index that contains stock ratings can act as internal research material as well as a marketing tool that aims to provide clients with transparency in stock analysis.?
ESG scores:
When it comes to Environmental, Social, and Governance (ESG) issues, a firm, fund, or security's performance is measured or evaluated objectively using an ESG score. Although the specific evaluation standards used by the many grading platforms that provide ESG scores vary, they all come under one (or more) of the E, S, or G categories.
The performance of a company is evaluated against each measuring criterion using ESG grading systems, which first generate a weighting for each criterion.?
How to use ESG scores for an index: ETFs
Advisors can build indices based on ESG scores that aim to address specific issues such as decarbonization or diversity and inclusion.
ESG indices can be turned into investable products such as ETFs, which can be traded on any exchange. The underlying index can be built by a third-party index provider in a low-cost and time-efficient manner.
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Thematic data:
Thematic data are categorical data sets used to identify securities with similar characteristics or themes that can be used to build investment strategies with exposure to certain areas of the economy.
How to use thematic data for an index: Thematic ETFs
Thematic data can be used to create indices that capture themes across various sectors and industries, including investing themes such as social issues, emerging technology, and demographic trends.
Thematic indices can be created in a time and cost-efficient manner, by utilizing modern and low-cost third-party index calculation agents that enables the easy construction, maintenance and distribution of thematic indices. These indices can then be turned into investable financial products, for example, thematic ETFs.??
Social and sentiment data:
Sentiment analysis is the systematic identification, extraction, quantification, and study of affective states and subjective data. It uses natural language processing, text analysis, computational linguistics, and biometrics. Investors can mine social media sentiment to give them information about stocks, cryptocurrencies, and commodities that they might not be able to uncover from more traditional means.
How to use social and sentiment data for an index: Index Series
Social and sentiment data can be compiled and used to backtest and build an index series that reflect on findings, which can then be distributed to clients and used as marketing materials.
Geolocation and satellite data:
28% of hedge funds currently employ geolocation data in their investment strategies, according to a research by EY (Ernst & Young).
For investors looking to better understand consumer behavior and, consequently, which businesses are seeing significant client demand and which are not, geolocation and satellite data can be very insightful datasets.
How to use geolocation and satellite data: Consumer behavior index data
With the increasing demand in geolocation and satellite data, investors are interested in understanding consumer behavior and are looking for easy ways to visualize and understand that data. A great way to understand consumer patterns of a group of companies is by creating an index that holds the stocks of companies that observe a consistent and high level of consumer habits and preferences.?
Conclusion
No matter what type of data you may have, you can use your raw data to build an index that can be used for several use cases, such as:
To learn more about how you can make sense of your data and build an index in an inexpensive manner, reach out to our team.
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