(Informationally) Overweight: Investors Need a Diet

Updated: Sep 19, 2020

Funnel taking in tons of information and investors trying to slim down what they look at

Discretionary investing is under fire these days. Passive investing and machines are taking over. Performance of discretionary managers has disappointed for years. But not everyone agrees.

We at TOGGLE believe the golden era for active managers is coming, and we are actively helping to build that future. To be sure, the task ahead is immense but we are confident technology is the way to tackle it. To understand why, we need to appreciate the nature of the challenge.

“Discretionary managers need to go on an information diet. They need help finding the right data, not more data.”

We have gone from a world where everyone was starved for data to one where data is everywhere: we are inundated with information. However, the investment community is still wired to always consume more and more information. The hunt is on for “alternative data” that holds the promise of more trade ideas and “alpha generation.” The fast growing mountain of data - 80% of our entire data stock has been created in the last two years - has happily fed this information addiction.

Big Spenders

Money Managers are ramping up spending on alternative data

chart showing the explosion of data purchases

The reality, however, is that investors only utilize a small proportion of the data they already have.

Analyzing drivers, seasonal patterns and correlations for 10 blue-chip US stocks across all of the related Refinitiv Data, we uncovered 60+ strong relationships between fundamental data and stock prices that were robust across business cycles and held up through many years. The patterns correctly identified the driver of a stock price an astounding 74% of the time. To put it into perspective, that’s almost 8 trades per quarter based solely on the most widely held dataset in the investor community, and across the most picked over stocks in the universe.

“Our tools are largely to blame. The technology to turn data into useful insights hasn’t kept up.”

Given how much value is left even in the core Wall Street dataset, much of the incremental data investors acquire is likely to be empty calories. Data that are stored as fat rather than turned into actionable insights. Investment managers are informationally overweight.

Data Explosion

The number of alternative data providers is rapidly growing

Chart showing the increase in the number of alternative data providers

Our tools are largely to blame. The technology hasn’t kept up as the investors suddenly faced extraordinarily wealth of data. By our calculations, you’re eight times more likely to get hit by lightning than you are to find a statistically robust pattern in Bloomberg or Datastream manually, using a spreadsheet [1]. These aren’t great odds for someone looking to generate exciting trade ideas and alpha.

Discretionary managers need to go on an information diet. They need help finding the right data, not more data, and they need help turning that data into ideas. Machines can help with the bodies-to-bytes ratio.

Their ability to crunch through numbers and detect anomalies is unmatched by human analysts. They can easily spot deviations from the norm and examine if those deviations have in the past led to stable response patterns in price. Moreover, thanks to cheap computing power, machines are better able to cope with the astounding growth in available data.

Consuming less, and healthier are among the tenets of a modern life...shouldn't the same apply to our investing?

[1] chance of being hit by lightning is 1 in 3.000 in your life according to the National Geographic (link), whereas TOGGLE identifies stable tradable relationships with a 1:25.000 frequency measured against a large number of possible data combinations