Introduction to Institutional Investment

Institutional investors are organizations that pool funds on behalf of others and invest these funds in various financial instruments and asset classes. They include investment funds such as mutual funds and ETFs, insurance funds and pension plans, as well as investment banks and hedge funds.

These can be contrasted with the individuals most often classified as retail investors.

Key points

  • Institutional investors are large market participants such as banks, mutual funds, pension funds, and insurance companies.
  • Compared with individual (retail) investors, institutional investors have greater influence and influence on the market and the companies in which it invests.
  • Institutional investors also have the advantage of professional research, traders and portfolio managers to guide their decision-making.
  • Different types of institutional investors have different trading strategies and invest in different types of assets.

Greater impact

Institutional investors control a large part of all financial assets in the United States and exert considerable influence on all markets. This effect has grown over time and can be confirmed by examining the concentration of institutional investors’ ownership of listed companies’ equity. Institutional investors own approximately 80% of the stock market value. As institutions continue to grow in size and importance, their relative holdings and their impact on financial markets are also increasing.

USD 88.5 trillion

According to McKinsey estimates, as of the end of 2017, the North American asset management industry controlled more than US$88.5 trillion.

benefit

Institutional investors are generally considered to be more proficient in investment because of the professionalism of their operations and because of their larger scale, they have easier access to the company. Over the years, as information has become more transparent and accessible, and regulations have restricted disclosure by listed companies, these advantages may have disappeared.

Asset allocation

Institutional investors include public and private pension funds, insurance companies, savings institutions, closed and open investment companies, endowments and foundations.

Institutional investors invest these assets in various categories. According to McKinsey’s 2017 industry report, the standard configuration is approximately 40% of assets allocated to equity and 40% to fixed income. The other 20% of total assets are allocated to alternative investments such as real estate, private equity, hedge funds, cash and other areas. However, these numbers vary from institution to institution. Stocks experienced the fastest growth in the previous generation. In 1980, only 18% of institutional assets were invested in stocks.

Pension funds

Pension funds are the largest component of the institutional investment community, controlling more than US$41 trillion in early 2018. Pension funds receive payments from individuals and sponsors, whether public or private, and promise to pay pension funds to beneficiaries in the future.

The California Public Employees Retirement System (CalPERS), a large pension fund in the United States, reported total assets of more than $390 billion as of June 7, 2020.Although pension funds face huge risks and liquidity constraints, they are usually able to allocate a small portion of their portfolio to investments that are not easily available to retail investors, such as private equity and hedge funds.

The operating requirements of most pension funds were discussed in the Employees Retirement Income Guarantee Act (ERISA) passed in 1974. The law establishes the responsibilities of trustees of pension funds and sets minimum standards for the disclosure, funding, attribution, and other important components of these funds.

investment company

Investment companies are the second largest type of institutional investment, providing professional services to banks and individuals who wish to invest their funds.

Most investment companies are closed-end or open-end mutual funds, and open-end funds will continue to issue new shares when they receive funds from investors. Closed-end funds issue a fixed number of stocks, which are usually traded on exchanges.

Open-end funds own most of the group’s assets and have experienced rapid growth in the past few decades as investing in the stock market has become more popular. However, with the rapid growth of ETFs, many investors are now moving away from mutual funds.

The Massachusetts Investor Trust was established in the 1920s and is recognized as the first open-end mutual fund operating in the United States.Others quickly followed up. By 1929, there were 19 open-end mutual funds and nearly 700 closed-end funds in the United States.

Investment companies are mainly regulated by the Investment Company Act of 1940, as well as other current securities laws in the United States.

Insurance company

Insurance companies are also part of the institutional investment community, and the amount of funds controlled by investment companies is almost the same. These organizations, including property and casualty insurance companies and life insurance companies, collect premiums to protect policyholders from various types of risks. The premium is then invested by the insurance company to provide a source of future claims and profits.

In most cases, life insurance companies invest in a portfolio of bonds and other low-risk fixed-income securities. Property insurance companies often have greater allocations to stocks.

Savings institution

As of December 2019, savings institutions control more than $1 trillion in assets. These organizations take deposits from customers and then provide loans to others, such as mortgages, lines of credit, or commercial loans. Savings banks are highly regulated entities that must abide by the rules for protecting depositors and the Federal Reserve rules on partial reserve banking. Therefore, these institutional investors invest most of their assets in low-risk investments such as treasury bonds or money market funds.

Most depositors in U.S. banks receive up to $250,000 in insurance from the FDIC.

foundation

Foundations are the smallest institutional investors because they usually obtain funds for purely altruistic purposes. These organizations are usually created by wealthy families or companies and are dedicated to specific public purposes.

The largest foundation in the United States is the Bill and Melinda Gates Foundation, which had $51 billion in assets at the end of 2019.The purpose of establishing a foundation is usually to improve the quality of public services, such as access to education funding, medical care, and research funding.

Bottom line

Although the share of institutional investors in all financial assets has remained flat in the past decade, they are still an important part of the investment community and still have a considerable impact on all markets and asset classes.

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