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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 entities that trade securities on a large scale, and sometimes even on behalf of commercial banks, mutual funds and a lot more. These large scale security trading entities are known as institutional investors. The investment strategies deployed by them are very different from the strategies used by retail investors due to the kind of access they have to the financial markets. In this article, we provide insight into institutional investors by examining the various sub-types of institutional investors, the impact that they have in the market, and how different they are from retail investors and still beneficial for an individual investor.
Defining an Institutional Investor
An institutional investor is a legal organisation 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.
- 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.
Individual Investors Vs Institutional Investors
- A 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 a few private investment options, which are typically not open to 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.
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 specialisation in specific asset classes and the investment strategies they follow. A few are listed below:
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 them more susceptible to larger gains and losses. Hedge funds are hence considered to be a more aggressive and riskier asset class.
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 risky options for beginner investors.
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.
Endowment Funds
Endowment funds are generally established by universities, hospitals, charitable foundations, or other non-profit organisations to manage their money. The income generated from investment activities is typically required to be used to finance the beneficiaries’ activities, such as providing scholarships etc..
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.
All the above-discussed categories of institutional investors charge asset management fees for managing investments, or taking 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?
- 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.
- Institutional investors carry significant power in the financial market (due to the considerable size of money involved) and, hence are able to exert large influence over the price dynamics of traded securities.
- Due to large monetary commitments, institutional investors develop expertise in tracking and monitoring investments, playing an active role in improving corporate governance practices. One may also learn the difference between small, mid, and large cap funds.
Retail Investors’ Benefit from Institutional Investor
- 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.
- Institutional investors are also better equipped with various analytical tools and technology, allowing them to make more accurate financial analyses when reviewing investment options.
Conclusion
Institutional investors are vital to capital markets. They exert great influence and have a 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.