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By Simon Constable 

The term "alternative facts" has been roundly ridiculed since its introduction into political discourse in 2017. There is, however, a similar phrase used in finance that investors should take seriously and understand: "alternative data."

Alternative data in finance refers to proxy metrics or information originating from unofficial or noncompany sources that individuals can use to gain insight into an investment. Such information can be the difference between making a profitable and unprofitable bet.

When measuring something as nebulous as investor anxiety, for example you need a proxy because if you survey individuals directly about anxiety "you may get a fuzzy answer," says David Ranson, research director at financial analytics company HCWE & Co.

Mr. Ranson instead looks at credit spreads, such as the ICE BofAML US Corporate BBB Option-Adjusted Spread, which measures how much more creditworthy companies must pay compared with the government to borrow money. That is, it measures the extra interest that investors require before they will lend money to companies.

When investors are anxious, the credit spread is wider. When they are less worried, it is narrower. Recently, the BBB spread was 1.54 percentage points, according to data from the St. Louis Fed, down from 2.06 percentage points on Jan. 3. That indicates that investors are far less worried now than they were at the beginning of the year. We know this because collectively, investors are willing to accept lower interest payments when they lend money.

"You aren't measuring the exact thing, but a symptom of it," Mr. Ranson says.

Some valuable metrics come from unofficial sources. That could include consumer activity on the web. For instance, research company IHS Markit regularly publishes alternative data, including the various purchasing-managers indexes, or PMIs. A PMI is a so-called diffusion index, which means that it registers whether a sector is growing or shrinking.

The advantage for investors is that they typically can get access to alternative data sooner than official figures.

Similarly, some companies collect information that investors can use to get a reading on the health of a public company before that firm reports results.

Eagle Alpha of Dublin collects data on consumer transactions, social-media activity and online searches that investors could use, say, to get a read on how much a streaming service's subscription base has grown or fallen. "Using that gets you inside the boardroom of the company," says Eagle Alpha founder and chief executive Emmett Kilduff. "You can't just rely solely on the data sets, but it is definitely a significant advantage."

Mr. Constable is a writer in Edinburgh, Scotland. He can be reached at reports@wsj.com.

(END) Dow Jones Newswires

December 08, 2019 22:14 ET (03:14 GMT)

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