Alternative data—information collected usually from industries outside the financial markets to provide traders and investors with exclusive and early insight into companies, their stock, and potential investment decisions—has been the hot topic among quants and data scientists in recent years. Demand for new insights has only intensified as the Covid-19 pandemic has disrupted the accuracy and value of traditional market indicators.

But despite demand for more alternative data, its providers—which usually focus on one core dataset, or a small suite of products derived from the same core data—are facing a quandary: How do they continue to grow their business? Can they continue hawking a single dataset to a wider audience? Do they need to develop other datasets—or merge with another provider already offering other data to broaden their appeal? Or do they need to be snapped up by larger vendors with existing distribution networks or private equity firms looking to create greater value by rolling them up with other start-up alt data providers facing the same issues?

Evan Schnidman, founder and managing partner of data advisory firm EAS Innovation, who sold his previous company, natural-language processing software vendor Prattle, to Liquidnet in 2019, says we’re already seeing evidence of consolidation among providers in the alt data space, and has been predicting the need for a roll-up among data providers serving the buy side since before he sold Prattle.

The thing driving this consolidation trend is the need to own the underlying data assets, and the need to be able to do something proprietary and unique

Evan Schnidman, EAS Innovation

He believes this because point-sourced solutions are difficult for asset managers to deal with, as they might have 40 or more vendors for their alternative data needs.

“Because there are so many players in the market, we’ve forced something of a race to the bottom, where firms have to spend so much on integrating these data sources, they can’t spend much on content,” Schnidman says. “If vendors can combine forces and offer a more integrated solution, they can achieve more pricing power, shorten sales cycles, and grow revenue at a faster rate. This strategy can even attract more attention from private equity firms who say, ‘You’ve already done the hard work; now we can roll you up with some other organizations,’” he says, adding that he believes there is still plenty of potential for more consolidation among providers.

Prattle was one of three companies acquired by Liquidnet—along with buy-side analytics provider Otas Technologies in 2017 and research aggregator RSRCHXchange also in 2019—to form a new business unit called Investment Analytics, which combines their technologies to deliver unique pre- and intra-trade analytics and insights.

“The thing driving this consolidation trend is the need to own the underlying data assets, and the need to be able to do something proprietary and unique,” Schnidman says.

This may be a reason behind global asset management giant BlackRock’s recent acquisition of staff from Ark Data, a start-up provider of a “community” platform for alternative data vendors and consumers—helping alt data providers to package their data to potential clients, much like Crux Informatics, and helping clients to assess and ingest alt datasets.

Sources say Ark was in the process of fundraising, and that BlackRock—which is building out its own cloud-based data and analytics offering, Aladdin Studio and Aladdin Data Cloud, in partnership with Snowflake—saw in Ark “an aligning of interests,” and made an offer to acquire the key people behind Ark but not any specific technology assets.

Those key figures are founders Rich Newman, who previously led the Open:FactSet Marketplace of alt data at FactSet, and Tim Gavin, who worked with Newman in FactSet’s content and technology solutions division, having joined the vendor via its purchase of his company Code Red, which developed research management software. In addition, BlackRock also hired Bryan Lenker, a 17-year FactSet veteran who was most recently director of Open:FactSet channel partners.

While a BlackRock spokesperson declines to provide further details of how the Ark team will contribute to its own cloud data efforts, one source familiar with the situation says, “The way to look at the transaction is not to think of it as an acquisition where BlackRock acquired Ark’s business and technology, but as an acquisition of know-how and intellectual property.”

Though that’s a new way to approach M&A in alt data, Ark isn’t the first alt data company—or even the first alt data aggregator—to experience consolidation. These deals have thus far been driven both by buyers wanting to capitalize on the success of alt data, others looking to fill a specific need or gap, and others still who haven’t been able to take full advantage of the growth of alt data. Still others have been squeezed out of a growing market, such as location data provider Thasos Group, which was acquired last year by Market Service Inc, a holding company that also owns AggData, another location data provider that provides information on the location of retail shoppers to predict impact on businesses. Even Bloomberg has got in on the act, and last December bought Second Measure, a provider of anonymized consumer transaction data used to predict company performance.

Among aggregators, Canadian alt data marketplace Quandl was acquired in 2018 by Nasdaq, which is now incorporating the platform into its new cloud-based Nasdaq Data Link offering. And with exchanges already actively buying environmental, social, and governance (ESG) data specialists, it’s likely that more exchange purchases of alternative data aren’t far off.

Chris Petrescu, founder and CEO of CP Capital, who has previously served as a data strategist at quantitative investment firm WorldQuant and head of data strategy at ExodusPoint Capital Management, says Nasdaq’s acquisition of Quandl was a statement that exchanges—which generally aren’t known for innovating, given their monopolistic positions—see data as a key asset.

“I think this trend has already been underway for some time, starting in 2015 when Standard & Poor’s bought SNL, which provided sector-specific fundamental data. Since then, there have been smaller and larger acquisitions, culminating in the S&P–IHS Markit deal, which is enormous,” Petrescu says.

He echoes Schnidman’s point that consolidation will make data sourcing and management easier for end-user firms, and also makes it easier for vendors with limited datasets to branch out into new areas and develop new products using acquired data, technology and expertise. “It’s almost always a question of buy vs. build: Could you build something yourself? Yes, but can you also get a company’s client list and its data?” Petrescu says.

To repeat Schnidman’s earlier comment: Alt data M&A is about the proprietary underlying data that these firms collect, and what they do with it that makes it unique.

Putting the ‘U’ in USP

There are two ways that alt data providers can offer something uniquely valuable, says Bruce Fador, CEO of data and fintech management and sales consultancy Fador Global Consulting Group: Either achieve the Holy Grail of doing something that no one else can figure out how to do, or find a new and better way to approach traditional, “mundane” datasets—i.e., by making alternative data “less exotic”—because “outlier” alt data providers don’t yet have wide enough market penetration. But even though he warns that trying to sell a company can get expensive—for example, an investment banker’s fees can be costly, especially for startups without huge revenue streams—he says a lot of data and analytics providers are actively in play.

A good example of a company bringing a new approach to old data challenges is Estimize, which was acquired in May by quantitative and alt data research firm ExtractAlpha. Estimize captured crowd-sourced estimates data from individual professional and retail investors, weighting them based on past success, to deliver scores frequently more accurate than Wall Street consensus estimates.

Having just gone through the acquisition and integration process, ExtractAlpha CEO Vinesh Jha echoes Fador’s warnings, but says that if you can take the pain, you can achieve the gains.

“It takes 10 times longer, 10 times as much paperwork, and three times as many lawyers as you would want. But from an operational perspective, we were able to combine sales and technology teams. There were some things being done separately that we could bring together and save costs,” Jha says. For example, with almost identical prospect bases, ExtractAlpha was able to cross-sell to Estimize’s clients, and vice-versa, and to find new value in—and hence, more ways to monetize—existing data by looking at it in different ways.

And it’s not just data providers feeling the urge to merge: Advisory firms that help startup vendors to identify those unique factors and position themselves to attract financial firms are also combining forces. For example, alt data advisory and sales services firm AltHub recently merged with Invisage Alpha, a UK-based provider of an artificial intelligence (AI) sales enablement and modeling platform, which AltHub will use to automate the data discovery and integration processes for data vendors and clients.

We’re in the second inning of alternative data. The first was identifying and cataloguing data. But now people are calling us and saying they don’t have enough data scientists, and they want companies to provide more analysis, and they want to know who else is using that dataset.

Scott Hall, AltHub

AltHub CEO Scott Hall says he expects to see more interest in “refiners” and “enablers”—the terms he uses to describe companies like AltHub or Crux Informatics that perform the data processing and transformation that enables alt data to be combined with and used alongside traditional datasets, compared to data owners or data marketplaces—as firms demand greater insights off the shelf.

“We’re in the second inning of alternative data. The first was identifying and cataloguing data. But now people are calling us and saying they don’t have enough data scientists, and they want companies to provide more analysis, and they want to know who else is using that dataset. So, in the next inning or two, you’ll see companies like us get more traction to satisfy that ‘dating game,’ and alt data will become more refined so it looks like other types of data,” Hall says.

And at the same time that buy-side firms are searching for more insights, private equity and venture capital firms are also showing more interest in companies operating in the alt data world—particularly those that Hall calls “refiners” and others providing tools to make alt data easier for firms to use.

“They’re buying in to the fact that these datasets are more in demand,” along with the services provided by those who make firms’ “alt data journey” possible by making the data usable out of the box, he says. “Before data can be delivered to a buyer, it goes through several steps that are not done well in the industry. You have to link the data back to something in the public markets, and that’s a lot of work. We’ve had to build our own security master tables.”

Schnidman, who sat on both companies’ advisory boards, says he’s “thrilled” that they’re merging, creating a single business of complementary skillsets. “I had suggested that they do some projects together, and they ran with it,” he says, adding that he played a similar role in last year’s acquisition of institutional ownership data and analytics provider Passiv.AI by Astrocyte Research, a provider of fund flows data and market risk and volatility forecasting tools.

Someone else thrilled about the companies merging is Barbara Matthews, a former senior counsel to the US House of Representatives’ Financial Services Committee and financial attaché to the European Union for the US Departments of State and the Treasury. Matthews had enlisted AltHub to help with strategy and sales support for her company BCMstrategy, which quantifies the effectiveness of public policy decisions and measures public policy risk.

“Today, firms assess public policy exposure by talking to experts. So it’s all based on opinion. In contrast, our process takes political science as its starting point and measures not content but action levels,” says Matthews, who was granted a patent for her process two and a half years ago after realizing she could automate that process. “Every day, we identify the delta between rhetoric and action—i.e., what governments are actually doing. That’s the opportunity value.”

BCM generates its policy risk scores, but also needed to develop its own lexicon of public policy language as training data for its process. The vendor has secured strategic relationships with the likes of Bloomberg and Dow Jones, but—with only three staff, including Matthews—the company enlisted AltHub to identify how to make its data more sophisticated and accessible, and to help it reach more of its target audience of global macro and sector-specific portfolio managers. But Invisage was able to bring additional insight that helped BCM’s development efforts.

“AltHub and Invisage suggested mapping the patented PolicyScope data to industry sectors. After I mapped the data, they suggested we backtest the daily data against common volatility measures like the Vix (Cboe’s Volatility Index) and mapping the data to industry sectors to demonstrate how far in advance our data anticipates market volatility. Invisage has just completed the backtest, and we look forward to sharing the results with the market,” Matthews says.

The Robinhood Effect

However, the changes underway in the alt data market signal that perhaps capital markets have only limited use for alt data, and that alt data providers will need to target new market segments if they want to grow beyond their current clientele. For example, Nasdaq says its new Data Link service will target “all segments of the investing public” and allow “more people to access information,” suggesting that the service is aimed more at retail investors and their brokers, rather than traditional institutional contributors of exchange order flow.

Interest from retail investors in access to more sophisticated data and analytics is driving providers of data and tools—such as the Miax International Securities Exchange, which recently described flipping the model for its Virtual Trading Floor hub of data and analytics—to focus on winning a higher volume of lower-value investors, rather than pursuing a smaller number of high-spending client firms.

This “Robinhood Effect” is simple: Why spend time and money wooing five hedge funds for $1 million deals when through word of mouth you can attract five million retail investors for $1 apiece, John Smollen, executive vice president and head of exchange-traded products and strategic development at Miax parent Miami International Holdings, recently told WatersTechnology.

This app economy and focus on the burgeoning market for retail traders with disposable income has led to one challenge affecting companies eyeing the next stage of their growth: outside funding—and specifically, its accessibility in an arguably overvalued market.

To date, startups have thought little about selling off equity stakes to fund important growth phases, like staff expansions, product development, marketing campaigns, and even M&A activity. But, as Schnidman points out, it’s hard to raise funding for anything significant—such as rolling up alt data providers into a larger and more valuable entity—when valuations can be significantly over-inflated (often a direct result of interest in a company quickly outpacing its ability to generate actual revenues).

“There is still a big opportunity for larger companies that have reached ‘escape velocity,’ but it’s hard to find financing for earlier-stage companies, especially when they are expecting valuation at 30 or 40 times revenue,” Schnidman says.

There are lots of interesting companies out there doing one thing really well. But I don’t know if they can make enough of a business out of just that for a venture capital firm to say, ‘This is the next big thing,’ and invest.

Vinesh Jha, ExtractAlpha

There’s another funding challenge facing alt data startups: their size. Schnidman says that even though more private equity firms have come to him looking for leads on potential acquisitions in the past year than in all of the past five years put together, private equity firms often find the deals on the table to be too small for their taste.

“When I have pitched a rollup to PEs, the response has been that many of these companies are simply not big enough. Most alt data companies are hovering below $5 million in annual recurring revenues, and most PE funds are looking for an anchor asset doing at least $20 million in annual recurring revenues so they can throw debt behind them,” he says.

For some, consolidation itself may be a route to funding deals, rather than the other way around, says ExtractAlpha’s Jha. “There are lots of interesting companies out there doing one thing really well. But I don’t know if they can make enough of a business out of just that for a venture capital firm to say, ‘This is the next big thing,’ and invest,” he says. “If companies have the same clients, it makes sense for them to consolidate and to be part of larger datasets, or to get access to a platform with new features.”

Brad Schneider, CEO of Nomad Data—which recently raised $1.6 million in seed funding from a group of venture capital firms led by Bloomberg Beta, the data giant’s venture arm, and angel investors—says traditional synergies associated with mature markets don’t necessarily transpire in fast-growing sectors like alternative data, which may deter potential buyers, as may the challenge of integrating complex datasets. Schneider sold his previous company, Adaptive Management, to data “wrangler” and integrator Knoema.

However, he says alt data presents interesting opportunities for banks, such as Jefferies, which in 2016 acquired ITG’s research arm (formerly Majestic Research) and renamed it M Science.

“A lot of these companies are starting to look like boutique research firms. Banks realize they need to differentiate their services with new research, and that it can increase revenues and sales,” Schneider says.

Follow the money

Yet revenues—and specifically, profits—remain elusive for many alt data providers, says David Riley, head of business development at Alqami, which helps financial firms identify and assess alt datasets, and also helps alt data sources productize and package their data in a way that financial firms can easily consume. And that revenue challenge is an obstacle to funding and M&A activity.

“There is willingness of private equity investor capital to come into this space, but mostly the revenue growth isn’t there to justify acquisitions. Yes, there’s a lot of money being spent on alternative data—multiple billions of dollars per year. But most of that is being spent with companies that are independent. Big banks, governments and corporates are not big in alternative data yet. Once they get into this space, we’ll see revenues go up,” Riley says.

And once alt data becomes a more visible and reliable revenue source, this will not only make startups more attractive to equity investors, but could also drive greater M&A by larger data vendors who will need to be able to offer alt data to those larger bank clients. But winning those larger deals takes time, and revenues won’t materialize overnight.

“With a lot of these large banks and asset managers, the investment cycle is longer, and to get any big money behind a decision, they have to do it as part of a budget cycle, and demonstrating how this adds to the bottom line and justifying the cost is very difficult,” Riley says. “They need to go through a rigorous investment case to get budget, which can take 18 months or two years, and after that, you still have to navigate the landscape of providers,” Riley says.

This is not only frustrating for firms eager to get started using alt data, but also for vendors desperate for money to start rolling in. Hence M&A between startups and larger “traditional” vendors who want to add data to their offering—and already have existing relationships with those clients, so they can bypass the lengthy sales and due diligence processes—could provide a win-win-win for all parties.

One of the lessons of the past decade was that the institutional equities market for alternative data was smaller than we all thought it would be, because discretionary asset managers and hedge funds never quite grasped how to generate alpha from this data in a systematic way. What ended up happening was that they used the data in an ad-hoc way … to validate their thesis.

Leigh Drogen, Estimize

Schnidman says that while consolidation is inevitable, with larger data companies likely to snap up alt data startups, what’s not inevitable is any guarantee that they’ll be able to monetize their new acquisitions. In some instances, legacy companies may simply struggle to integrate more innovative startups because they are so dissimilar, both in terms of culture and their technology stack, or even the personalities (and egos) of those involved—so a key skill of anyone trying to buy and roll up companies, or play matchmaker, is recognizing not only technologies and tools that will work together, but also if leadership and staff will work well together.

“Each company is somebody’s baby, so you have to be respectful. You each come in with different priorities, so you have to reconcile those,” Jha says. “In our case, Leigh [Drogen, founder and CEO of Estimize, who is now pursuing a new venture in a different sector of financial markets] and I trust each other and have known each other for many years. And we’re small companies, so there wasn’t a big culture clash.”

And while management squabbles or M&A distractions can hamper a firm’s ability to capitalize on acquisitions and continue its growth trajectory, in other cases, a buyer’s ability to monetize a new acquisition may simply come down to hitting the ceiling of its addressable market, adds Drogen.

“One of the lessons of the past decade was that the institutional equities market for alternative data was smaller than we all thought it would be, because discretionary asset managers and hedge funds never quite grasped how to generate alpha from this data in a systematic way. What ended up happening was that they used the data in an ad-hoc way … to validate their thesis,” he says.

Alternative clients

That’s why alt data companies are already casting their nets wider in the hope of snaring a broader base of clients.

AltHub’s Hall says independent research houses are known to be looking at using alternative data more widely as an input to research, and says there are rumors that sell-side firms are looking at building or buying alt data marketplaces to sell data and signals to buy-side clients trying to figure out how to build research operations focused on alternative data. In addition, he says corporations using data to provide competitive insights—which don’t have fiduciary responsibilities associated with their use of the data, and don’t have such demanding requirements of the data itself—represents a big market for alternative data.

Petrescu believes a lot of the future growth in the market will come from companies outside the capital markets, such as for competitive intelligence and company analysis for corporate clients.

“For example, advertising technology tracking companies have been selling to corporates for far longer than they’ve been selling to hedge funds,” he says, adding that alt data companies often start in the corporate sector and pivot into capital markets—with mixed success—but that the “real dividends” could come from expanding into the much broader non-financial sectors.

Schnidman echoes this sentiment. “In the last six months before we sold Prattle, our fastest-growing market segment was corporates—especially the investor relations community within corporations,” he says, adding that while this sector may not generate as much revenue per client as buy-side firms, the sheer number of potential corporate clients makes it an attractive market for vendors of any data or tools that can provide competitive insights and business intelligence. “I spend a lot of time talking to corporates because they spend a lot of time focused on optimizing how they communicate with investors, and thus determining how investors are measuring company performance.”

Covid and beyond

In the end, the future of the alt data industry may be shaped by the competing values of a company’s founder, leadership, and investors. It seems inevitable that in such a competitive market, most won’t survive as independent providers of one or two alt datasets. “So, your choices are to focus on building value in the short term and maximizing the outcome of a sale, or to roll the dice, combine with someone else, and hope that one plus one makes three,” Schnidman says. “It depends what you are optimizing for—money right now, or long-term growth?”

It may also be shaped by how things change as we emerge from the grip of the Covid-19 pandemic, which has compressed investment timelines and prompted traders to focus on short-term datasets rather than historical trends that played out during “normal” times.

The challenge about history is that the last 18 months are meaningless from a five-year backtesting requirement. Some funds are re-assessing how they test data because the old models don’t work.

David Riley, Alqami

BCMstrategy, for example, has only been collecting data for two years, which traditionally would have been too small for financial firms to base decisions on. “We expected we would need at least three to five years of data to satisfy the needs of capital markets,” says BCM’s Matthews. “But Covid has changed the game for how decisions are made and how much historical data people want. Markets seek to implement more robust nowcasting, which means they place a higher priority on near-term data. Our datasets are particularly positioned to provide perspective on near-term decisions using near-term public policy data, which is often a material risk driver during the pandemic.”

Alqami has also noticed the difference. “The challenge about history is that the last 18 months are meaningless from a five-year backtesting requirement,” Riley says. “Some funds are re-assessing how they test data because the old models don’t work.”

This has provided a short-term boon for companies that otherwise might have faced a much tougher 2020 and 2021, as during an unfamiliar climate, financial firms turned to unfamiliar datasets, whereas competition may have caused more attrition in normal circumstances, says Christine Short, vice president of research at events data vendor Wall Street Horizon.

“Everyone is trying to get information that gives them an edge, and are trying to take advantage of more retail money in the market. So what started out as looking like a precarious position turned into a big win for these companies.”

But the climate could easily turn precarious again. Now, as alternative data enters its second inning, and as the volatility created by Covid inevitably settles, so may demand for some alt datasets, which may force M&A whether companies like it or not.