Updated July 17, 2023
Definition of Institutional Investors
Institutional investors are companies, business units, or legal entities that take funds from their clients, create a pool and use it to invest in various financial instruments like pension funds, mutual funds, stocks, bonds, etc.
These entities have high creditworthiness and solvency compared to retail investors. This includes commercial banks, mutual fund companies, insurance companies, endowment funds, hedge funds, etc.
Institutional investors are considered large market players in the stock market, and they possess extensive market knowledge and resources to invest in various investment opportunities which may or may not be available to retail investors. Since they consider big players, they are subject to fewer regulations from regulatory bodies. Their act of hefty buying and selling of securities impacts the whole stock market and can result in a change in the stock prices.
Different institutional investors follow different strategies or plans for investments. Since they greatly influence market forces, they carry out a high level of transactions on primary stock exchanges. Institutional investors buy and sell in block trades with 10,000 shares or more in one go compared to retail investors who invest in round lots, i.e., 100 shares or more.
Characteristics of Institutional Investors
- They consider as big fish in the stock market or large players.
- They deal with significant or large funds belonging to their clients.
- They generally invest or manage the client’s assets per their needs, requirements, and risk appetite.
- They are a separate business unit or legal entity managing clients’ funds.
Types of Institutional Investors
- Commercial Banks: Commercial Banks takes money from customers in various forms like savings, fixed deposit, and current account and provide loans to other needy clients like mortgage, business loans, etc. They provide interest to the customers for saving and deposits and charge interest from customers on loans they have provided. They invest their funds into less risky options like treasury or money market funds as these entities are highly regulated.
- Mutual Funds: Mutual fund companies create a pool of investment from the customer’s money and then invest in diverse investment options like stocks, bonds, and other fixed-interest securities. In return, they promise to provide a high rate of return subject to the performance of the fund in which money invest.
- Insurance Companies: Insurance companies take their clients’ monies as a premium and, in return, provide them insurance against life, property, casualty, health, etc.
- Pension Funds: Pension fund companies take funds from their customers and invest them in various financial instruments. In return, they promise their customers to provide retirement benefits in the future.
- Endowment Funds: Endowment funds are generally held by the non-profit or charity organizations in which the principal remains invested, and any interest thereupon uses by the non-profit organizations to carry on their day-to-day operations.
Why are Institutional Investors Important?
The significance or importance of the institutional investors can comprehend from the below points:
- It serves as an important source of capital in the economy, as they create a large pool of funds with the help of their customers. They inject these funds into different investment options and fulfill the needs of the companies needing funds for their running.
- Individual investors who cannot invest in the funds which require a large minimum capital requirement can invest in them through the help of institutional investors and also benefit from the services of the professional fund managers appointed by the institutional investors to manage their client assets.
- Institutional investors invest in large chunks, i.e., through block trade (large size of the investment fund) which allows them preferential treatment like lower transaction cost, fewer regulations, and quicker execution of their order. This benefit is also reaped out by the investors who have given their funds to institutional investors for investment purposes.
Impact of Institutional Investors
Institutional investors exercise great control over the market forces of demand and supply. This control is because they are large market players and generally carry out a large investment in one go. Due to the large size of transactions in the stock market, they can impact the price of the securities and create an imbalance between the supply and demand of the particular stock or securities. They can lead to positive as well as negative changes in stock pricing.
Apart from the price impact, as big investors, they also help the economy’s overall growth by injecting a large amount of funds from time to time. They also provide opportunities to individual investors to invest in the funds through them, which they would not have been able to do individually due to the limitation of the minimum fund required.
Some of the advantages are given below:
- Institutional investors manage risk in a better way in comparison to the individual investor.
- They appoint professional fund managers to manage clients’ assets who can do it much better according to the client’s needs, requirements, and risk appetite.
- A higher capacity for investment helps them in achieving economies of scale.
- An individual investor can reap the benefit of professional service, invest in securities not available for individual investors, and better manage their risk by investing through institutional investors.
- It helps in the overall economic growth of the country.
Some of the disadvantages are given below:
- As institutional investors hold great control over the market forces, sometimes they can use this power to manipulate the pricing of the stock or security to their advantage.
- The investors who have invested through institutional investors have no power over the decision of the companies they have invested in.
- If an institutional investor exits the market, it will impact the whole market, and investors will take it as a warning sign affecting the stock price.
Institutional investors are an important part of the capital market and the economy. They play a major role in injecting funds into the economy and act as intermediaries between the idle funds lying with the investors and the borrowers who need the funds to start up a new business or maybe for the growth and expansion of their current business. They greatly influence the market and can use this power in negatandl and positively. Therefore, regulators should ensure they do not take advantage of this power by making them follow certain rules and regulations.
This is a guide to Institutional Investors. Here we also discuss the definition and types of institutional investors, their advantages, and their disadvantages. You may also have a look at the following articles to learn more –