Not all investors in the stock market are retail investors or individual stakeholders, who deal in bonds/stocks as per their own pick and choose policy. There are also large entities too, who trade securities on a large scale, and sometimes even on the behalf of commercial banks, mutual funds and a lot more.
These large scale security trading entities are known as Institutional Investors and they account for the majority of the trades in the market. The investment strategies deployed by Institutional Investors are very different from the strategies used by retail investors due to the kind of access they have into the financial markets.
In this article, we provide an insight into institutional investors by examining the various sub-types of institutional investors, the impact that they have in the market, how different they are from retail investors and still beneficial for an individual investor.
What is an Institutional Investor?
An Institutional Investor is a legal organization that pools funds of a large number of individual investors or other legal entities, and invests in different financial instruments such as stocks, bonds, commodities or any other investment options. In short they invest on behalf of their clients as they are considered highly sophisticated investors who possess extensive investment knowledge and experience. Institutional investors are very less likely to make poor investment decisions, as they are capable of in-depth analysis, including risk and returns forecasts and are able to develop sophisticated financial models as compared to individual investors.
As discussed above as well, their approach and strategies to the financial markets are very different from the individual investors. Let’s discuss the difference between the two in detail.
How Retail/Individual Investors are different from Institutional Investors?
- Retail Investor is an individual who deals in securities via brokerage firms or other facilitators, whereas Institutional Investors invest on behalf of retail investors.
- Institutional Investors have access to securities and markets of all kinds even to few private investment options, which is typically not open for the retail investors, such as institutional real estate, or private stock placements.
- Retail investors invest on behalf of themselves hence the investment amount tends to be much lower in size compared to the investment amount made by institutional investors.
- Institutional Investors heavily impact the demand and supply of securities, directly affecting the price movements of the securities as compared to retail investors due to the obvious difference in the investment size.
- Retail investors are more susceptible to emotional biases compared to institutional investors.
Now when we clearly understand what an institutional investor is, let’s understand the different types of institutional investors.
What are the different types of Institutional Investors?
Institutional investors are broadly divided into Foreign Portfolio Investors [FPI] and Domestic Institutional Investors[DII] depending on whether the investments are from domestic or foreign institutions in the Indian financial markets.
There are several different types of institutional investors in the market depending upon their specialization in specific asset classes and the investment strategies they follow. Few are listed as below:
1. Hedge Funds:
Hedge funds are one of the most well-known types of institutional investors in the financial world. Hedge fund investors are locked into the investment for a longer period of time without the freedom to cash out and exit. In addition, hedge funds typically use a concentrated investment strategy, where funds are directed to a few assets in larger proportions, making it more susceptible to larger gains and losses. Hedge funds are hence considered to be a more aggressive and riskier asset class.
2. Mutual Funds:
Mutual funds are a well-diversified form of investment across different industries and sectors available in the market. They are designed to mitigate the risk of capital losses for their investors through diversification. Mutual funds typically do not have entry requirements for investors and are open to individual or retail investors even with a small investment size. Mutual Funds are considered as one of the most attractive and less riskier options for beginner investors.
3. Insurance Companies:
Insurance companies are one of the high impact institutional investors. The premium these insurance companies receive from investors is very well managed and invested in securities, returns of which are used to repay the investors. Due to the considerable amount of premium received and invested they become one of the important institutional investors directing the markets.
4. Endowment Funds:
Endowment funds are generally established by universities, hospitals, charitable foundations, or other non-profit organizations to manage their money. The income generated from investment activities is typically required to be used to finance the beneficiaries’ activities, such as to provide scholarships etc..
5. Pension Funds:
Pension funds are funds established using monetary contributions from pension plans. Both employee and employer can contribute to the pension plans. The accumulated capital is typically allocated to income generating and stable investments, fulfilling the whole purpose of pensions, i.e.generating stable and regular income.
Note: All the above discussed categories of Institutional Investors charge asset management fees for managing investments, or take a share of profits should investments make money, as per the agreement between the individual and fund manager.
How Institutional Investors Impact The Indian Stock Market?
1. Institutional investors are crucial to financial markets as they provide capital to businesses along with providing liquidity to the financial securities they trade in the market.
2. Institutional investors carry significant power in the financial market (due to the considerable size of money involved), hence are able to exert large influence over the price dynamics of traded securities.
3. Due to large monetary commitments, institutional investors develop expertise in tracking and monitoring the investments, playing an active role in improving corporate governance practices.
How can a Retail Investor benefit from an Institutional Investor?
1. As already discussed in the post above institutional investors have access to private investment options which retail investors are deprived of. An individual or retail investor can gain access to exclusive investment opportunities via institutional investors through methods like co-investing.
2. Institutional investors are also better equipped with various analytical tools and technology, allowing them to make more accurate financial analysis when reviewing investment options.
To sum up, institutional investors are vital to capital markets. They exert great influence and have considerable impact on all asset classes and markets. As an individual it is important to have a constant look at what these biggies are up to and understand the actions of these market movers to predict the overall market movement. ShareIndia closely observes the Institutional Investors and shares the insights regularly. Follow ShareIndia Instagram page for regular updates of the FPI and DII movements.
Disclaimer: Any Advice or information in the post is a general advice for education purpose only and is not responsible for generating any trading strategy for anyone, please do not trade or invest based solely on this information.