Alternative Data Is the New Paradigm for Monitoring Investment Risk
As we begin 2022, we are all too aware of the levels of uncertainty surrounding us. The pandemic and its recovery continue to cast a shadow on every day life. The supply chain crisis remains a disruptive force, hitting stock prices and supermarket shelves alike, while the inflationary backdrop puts pressure on markets and economies worldwide. Topline - the 2022 outlook for investors is complex and riddled with risk.
Reflecting on the lessons learned over 2021, a year similarly characterized by disruption and uncertainty, could prove helpful as we embark on a new year. January 2021 saw investors weather the Game Stop storm. Indeed, hedge funds lost $20bn over the course of 2021 due to meme stock rallies creating short squeezes that they were too late to identify and mitigate against.
New year, new asset classes, new risks
As the various meme stock rallies demonstrated, retail investors are now congregating more readily in digital channels, driving asset prices in unexpected ways and thereby making returns more volatile than anticipated. The launch of more digital channels (NFT market places, for example) has provided further avenues for investors to establish new communities online, where investment bubbles can also build and dissipate in minutes.
The rapid changes to risk profiles for assets, and therefore returns, have made investors re-evaluate assets historically deemed ‘safe’ and/ or forever immune to volatility. And the fact is that traditional data alone cannot provide the necessary 360 degree view of the markets that is necessary to monitor and manage risk.
In order to accurately evaluate the impact of online sentiment to portfolio returns, investors now need to supplement their analysis with alternative data sets that monitor investment signals as they emerge in digital channels.
Monitoring digital channels provided early warning systems of an upcoming short squeeze (Sentifi detected sentiment and attention buzz changes for Gamestop three weeks before the stock’s 351% price movement). For hedge fund managers who have not incorporated monitoring momentum changes from social media, news, forums and blogs into their investment decision making processes, the emergence of these new risk factors will likely to cause unanticipated impact to portfolio returns.
Monitoring the changing perception of systemic and systematic risk to make informed investment decisions
If 2021 taught institutional investors anything it was the need to acknowledge the correlation between online sentiment and market momentum changes.
In essence, the new paradigm for risk management means monitoring market momentum changes as they emerge in digital channels to make informed decisions around impact to portfolio valuation.
What can this type of monitoring highlight with respect to risk? Certainly, the need for alternative data extends to the assessment of systemic and systematic risk. Traditional macro and micro economic data sets, with their embedded time lags, cannot monitor the changing perception of risk in specific sectors, industries, countries and regions as well as in the broader market.
Comparing the reports of risk events across sectors in the past twelve months vs. past three months in digital channels like Twitter, news, forums and blogs suggests that the perception of the risk profile of the real estate, health care and communication services sectors has degraded the most as risk scores increased by 11.11%, 9.68% and 9.09% respectively. Returns in the S&P 500 real estate, health care and communication services sector indices has declined by approximately 4.94%, 4.65% and 2.69% respectively in the quarter to date (Source: S&P Global – Quarter through Jan 10th 2022). It is clear that monitoring the changing risk profile of sectors in digital channels provides additional insights on the potential impact of changing risk profiles for specific sectors to portfolio returns.
From a regional perspective, the perception of risk from risk events reported in digital channels like twitter, news, forums and blogs has improved the most for the United Kingdom and Australia and New Zealand with a decrease of 20.51% and 14.29% in their respective risk scores. By contrast, the risk profile of Japan and North America has increased by 8.82% and 6.25% respectively.
As the recovery from the global pandemic starts to materialize in different ways across regions, sectors, industries and individual companies, not monitoring digital channels for an evaluation of investment risk could mean that institutional investors have blindspots that degrade portfolio value in unexpected ways.
Monitoring the changing perception of risk associated with digital asset classes
In 2022 volatility is expected to continue for digital assets whose valuation is largely driven by market sentiment. Monitoring momentum changes in social media, news, forums and blogs provides indicators of likely direction of price movements.
Chart 1 below depicts the inverse relationship between the Sentifi Bitcoin Risk Score and the Bitcoin closing price. Sentifi’s Risk score is capturing sentiment/momentum (or market confidence) in bitcoin. As prices rise and more investors are attracted to Bitcoin as an investment, the volume of positive mentions in social media, news, forums and blogs outweighs the volume of negative mentions. Sentifi’s risk score captures this momentum change.
Periods where Sentifi’s risk score for bitcoin is low (i.e., when market confidence in bitcoin is high) coincide with periods where the closing price of bitcoin peaked. Monitoring this new indicator therefore signals when the downside risk for Bitcoin is significant.
As we step into 2022, investors need to adjust to a new paradigm for monitoring investment risk - consulting alternative data will only better improve investment decisions.
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Marina Goche is CEO of Sentifi
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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group
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