An Institutional Investor is an organization or a legal entity that trades in the market on behalf of its clients that may be retail investors.
An Institutional Investor is an organization or a legal entity that trades in the market on behalf of its clients that may be retail investors. Institutional investors have been termed the “elephants’’ of the stock market given their profound influence over the prices as they trade with hefty volumes on a daily basis.
The role and share of institutional investors have increased massively over the past decade. They now reign over 70% of the trading volume in almost all the asset classes. Mostly, these investors do not trade their own money but make a profit off their clients’ investment portfolios.
The latest changes in the market structure introduced by the advent of quantitative and algorithmic trading have further accentuated the need for institutional investors. They manage multiple funds simultaneously and act as vehicles of pooled investments. With a honed team scrutinizing the continuous shifts in market indices and elaborating market swings, institutional investors are better equipped to trade when the time is right, without being exposed to the same risk as a retail investor. Compared to retail investors, institutional investors are more apt and experienced navigators of financial instruments. One of the advantages is having sell-side analysts providing them with invaluable consensus estimates, helping the latter make informed decisions that can improve the value of portfolios in the long run.
Institutional investors trade in such large volumes that they have the ability to affect the price discovery mechanism and contribute to market growth. The pooled money introduced by these investors is pivotal to the market. It is generally accepted that institutional investors, being legal entities, are less likely to lag in compliance with the law. Being more experienced, they are less prone to risk and know how to use their stop-loss orders timely, keeping losses to a minimum.
There are many types of institutional investors. The six main ones are:
Insurance Companies: Investment comprises the pooled premiums from various clients in exchange for health coverage etc., with claims being compensated directly from the investment portfolio.
Mutual Funds: It is a diversified form of investment in which a professional manager deals with an investment pool, with each contributing investor having ownership of varying share percentages. Often selected by novice investors, mutual funds usually deal with liquid assets on a long-term basis.
Hedge Funds: Employing aggressive strategies to stomp competition and use maximal leverage, hedge funds are basically pooled investments in which the manager acts as the general partner and the investors become the limited partners. Liquid assets are majorly traded in hedge funds.
Banks: Banks, including commercial and central, invest on behalf of their clients e.g. bonds, private equity funds, etc.
Credit Unions: It is a financial organization that offers shares that can be bought at pre-determined rates by its members. The profit is reaped by the members, who are also the owners of the organization.
Pension Funds: It is a pool of investment, contributed by private and public sponsors that cover the post-retirement era of their select beneficiaries.
A retail investor is not limited by any tenets and can choose to invest in whichever portfolio they deem fit. An individual, a small-cap investor, can also focus on a short-term investment with quicker gains. In contrast, an institutional investor is more goal-oriented and prefers long-term, large capital investment.
A retail investor prefers to play safe. A volatile market may scare off an individual investor, but large institutional investors prefer to take advantage of the swings to maximize gains. The market navigation by institutional investors is programmed by side-sell analysts and other experts.
As opposed to retail investors, an institutional investor can procure and manage larger market activities.
Multiple asset acquisitions are possible for an institutional investor and not feasible for a retail investor. The former has the advantage of preferential market treatment and looser regulations and is better able to procure foreign securities and other such amenities.
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