INSTITUTIONAL INVESTORS: Meaning, Types, Resources, Institutional Vs. Retail Investors

Meaning of An Institutional Investor

An Institutional investor is a person or an organization, however other than a bank that trades securities in large enough share quantities that it qualifies for preferential treatment and lower commissions. In simple terms, institutional investors trade securities on behalf of its members.

Institutional investors face far lesser protective regulations as it is believed that they are knowledgeable and are better equipped to protect themselves.

Types of Institutional investors

Generally, six types of institutional investors exist.

Endowment fund

This refers to a legal structure for managing, and often indefinitely perpetuating, a pool of financial, real estate or other investments for a specific purpose, according to the will of the founders or donors. Endowments are structured in a way that the principal value is kept intact, while a smart part of the investment is available for use each year.

Commercial banks

These are financial institutions that accept deposits from the public and create credit. The lending activities are performed directly or indirectly through the capital markets. In many countries, banks are highly regulated.  

Mutual funds 

Mutual funds are professionally managed investment funds that pools money from many investors (either retail or institutional) to purchase securities.

Hedge funds

These are investment funds that pools capital from accredited investors and invest in a variety of assets and are associated with complicated portfolio-construction and risk management techniques. The funds are administered by a professional investment management firm and structured as a limited partnership, LLC or a similar vehicle.

Pension funds

Pension funds are plans, funds or schemes that provide a means of retirement income. Pension funds usually have large amounts of money to invest and are the major investors in listed and private companies.

Insurance companies

 These are companies that provide a means of protection from financial loss. Insurance serves as a form of risk management to hedge against the risk of a contingent or uncertain loss.

As an individual, you necessarily must not be an institutional investor, however, there are several chances that an individual or organization could be investing on your behalf. For example, if you have got investments in mutual funds or you are probably saving towards your retirement in a 401(k) retirement account, it then simply means that your fund is being handled by an institutional investor. Individuals who have pension funds coming their way, have their funds being managed by an institutional investor. You could also make donations to charity or your alma mater, and the funds are moved to an endowment account and the funds are invested in securities to maximize more gains.

Resource Tools of Institutional Investors

There are a variety of resource tools that Institutional investors use as well as specialized knowledge for extensively researching a variety of investment options that are usually not open to their counterparts, that is the retail traders. The largest force behind demand and supply in the securities markets are the institutional traders, hence they perform the majority of trades on major exchanges and greatly influence the prices of securities. This is the reason why, retail investors often focus their research on the regulatory filings  of institutional investors with the Securities and Exchange Commission (SEC) in order to know which securities they - retail investors - should buy personally.

Retail investors tend to have a diversified portfolio and often do not invest in the same securities as institutional investors. They use this as a means to avoid paying higher prices for the securities.

Contrasting Institutional and Retail Investors

Several differences exist between institutional and retail investors and a few of them are outlined below.

·      Both kinds of investors, that is institutional and retail investors invest in different types of securities including bonds, futures contract, options, mutual funds, ETFs and stocks. The major difference is that due to the nature of the securities and the way the transactions involved take place, some of the security markets are typical of institutional investors, while other markets are typical of retail investors. Swap markets and forward markets are examples of market that are primarily for institutional investors. For each trade, retail investors pay brokerage firms some fees as well as distribution and marketing costs. In the case of institutional investors, trades are sent independently or through intermediaries through exchanges where the fee for each transaction is negotiated upon. Also, payment for marketing and distribution costs are avoided.

·      Institutional investors buy and sell stocks in block trades of 10,000 shares or more, while retail investors buy and sell stocks in round lots of 100 shares or more. Institutional investors often try to avoid buying the shares of smaller companies and acquiring a high percentage of company ownership as a result of the larger trade volumes. Also, this is because the investment cannot be sold when desired for little or no loss in value, because carrying out such act may lead to violation of security laws. For instance, securities that are registered as diversified funds are restricted to the percentage of a company's voting securities that the funds can own. Such registered diversified funds include mutual funds, closed-end funds and exchange-traded funds (ETFs). In contrast, retail investors often find the lower stock prices of small companies attractive. This way, it becomes easier to invest in more diversified portfolios with small range prices than those with a higher price range.

Influence of Institutional Investors' Activities on the Securities Market.

Majority of trades that take place in the markets are carried out by institutional investors. It is currently estimated that over 70% of the stock trading volume can be accounted for by institutional investors. According to statistical data available, in the last 60 years, the percentage of corporate shares held by institutional investors has drastically increased. Currently, the volume of trades carried out by retail investors is quite small compared to that carried out by institutional investors.

Several analysts have voiced out that the rise of institutional investors, especially index funds, is quite disturbing. They further say that if about 20% of stocks are being owned by index funds, the indexing will result in distortion of the market and that the economy could suffer greatly if index funds should ever dominate the stock market. The analysts argue that when passive investment dominates the market, majority of stocks will not be bought on the basis of rewarding well managed, productive, promising and profitable companies. This could also lead to distorting market mechanisms that are used in determining the prices of commodities.