Portfolio managers and analysts are constantly on the lookout for new tools that can give them an edge. At the 67th CFA Institute Annual Conference in Seattle this week, attendees heard from a trio of entrepreneurs whose start-up companies are harnessing the power of online collaboration and crowdsourcing to deliver exactly that. They included Leigh Drogen (pictured), founder and CEO of Estimize, which provides crowdsourced earnings estimates that are more accurate than the Wall Street consensus; Joseph A. Gits IV, CFA, CEO and co-founder of Social Market Analytics, which taps into Twitter’s data stream to quantify predictive social sentiment for equities; and Divya Narendra, CEO of SumZero, an online community where buy-side investment professionals can share and rate investment opinions.
One big question at the intersection of social media and professional finance is whether open or closed communities deliver better results. Some research suggests that smaller, closed communities are better able to surface alpha-generating ideas than larger ones, while others have found that “social learning” improves investment decision making only when individuals in a network bring different information to the table. Drogen contended that an open platform improves data quality on Estimize by allowing analysts, students, or even kids in their basement to contribute to a consensus number that is ultimately more representative of market expectations. An open platform allows the estimate to consolidate as much information as possible. The “secret sauce” for making this work is a proprietary algorithm that evaluates whether each contribution is reliable. In Drogen’s view, there could be as many as 50 identified characteristics of analysts that contribute to alpha, but recency of the estimates and correcting for the biases in sell-side analyst estimates, which are not updated enough, are the two most important.
Gits, CEO of Social Market Analytics, observed that closed communities tend to have a lower volume of information but a high signal-to-noise ratio, whereas open platforms provide access to large volumes of data with a very low signal-to-noise ratio. He pointed out that there are 250 million active accounts on Twitter, of which roughly 500,000 regularly reference companies or securities. By looking at the entire stream published by those 500,000 contributors, including the history and frequency of tweeting, the universe can be further filtered to about 50,000 “legitimate” contributors worth monitoring. He argued that this screening process can generate statistical alpha.
For SumZero’s Narendra, the up-front vetting process employed by his site is an important contributor to better-quality research and helps maintain a standard of transparency for users. The vetting process ensures that all contributors meet certain levels of financial knowledge, he said. All of the research content on the site is clearly attributed, which provides contributing analysts with an incentive to be rigorous as they work to establish a track record for themselves and build their reputations.
— Larry Cao, CFA (@LarryCaoCFA) May 6, 2014
How can investment professionals best leverage social finance platforms? Narendra pointed out that online communities like SumZero can help investors with limited resources — small family offices, for example — obtain access to research that they would not otherwise be able to afford. Hiring analysts, after all, is expensive. Crowdsourcing can help supplement what a small firm is already doing by adding breadth and depth.
For Social Market Analytics, the “product” is data rather than research, so it is up to financial professionals to develop and implement trading strategies that incorporate the signals, Gitts said. For portfolio managers, social data can help generate additional trading and investment ideas.
According to Drogen, quant traders are using crowdsourced earnings estimates in their trading systems as a complement to I/B/E/S estimates. Fundamental analysts also use the estimates to get a perspective on where their own numbers stand relative to others in the market. But eventually, Drogen contended, crowdsourced earnings estimates could become replacements for current industry standards given the superior accuracy.
For more information, read “Social Finance: Have We Reached An Inflection Point?” by Len Costa of CFA Institute, who moderated the session.
If you liked this post, consider subscribing to the CFA Institute Annual Conference blog.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
Photo credit: W. Scott Mitchell