3 min
26-August-2024
Institutional investors are companies or organizations that manage and invest funds on behalf of others. Examples of such investors in India include mutual funds, pension funds, and insurance companies.
The financial market is composed of primarily two types of investors–retail investors and institutional investors. While retail investors are regular investors who invest their own money in the securities market, institutional investors are investors who invest on behalf of others.
Institutional investors are investors like mutual funds, insurance companies, central banks, commercial banks, hedge funds, and pension funds that pool money from different entities and invest the same to generate positive returns. This article discusses the meaning of institutional investors and their roles, characteristics, impact, and types in detail.
Additionally, institutional investors make investments according to the interest of the actual investors. In other words, the asset allocation strategy matches the investors' interest. Their goal is to generate positive returns for investors. Institutional investors can also engage in active trading or participate in market segments, like the forward markets, which are inaccessible to retail investors.
Understanding the role and impact of institutional investors can help you better understand how mutual funds work. Once you’ve mastered that understanding, you can start investing in mutual funds through the Bajaj Finserv Mutual Fund Platform. This smart and intuitive platform allows you to compare mutual funds and invest in the best options online with just a few easy clicks. Moreover, you also have a free mutual fund calculator at your disposal to compute your potential returns and trim your financial plan accordingly.
The financial market is composed of primarily two types of investors–retail investors and institutional investors. While retail investors are regular investors who invest their own money in the securities market, institutional investors are investors who invest on behalf of others.
Institutional investors are investors like mutual funds, insurance companies, central banks, commercial banks, hedge funds, and pension funds that pool money from different entities and invest the same to generate positive returns. This article discusses the meaning of institutional investors and their roles, characteristics, impact, and types in detail.
What is an institutional investor?
An institutional investor is a company or organisation that pools money from other entities and invests the pooled funds in different market securities on their behalf. Mutual funds, pension funds, and insurance companies are common examples of institutional investors. Institutional investors can pool funds from individuals as well as other entities. Since these investors generally trade in large blocks of securities like stocks, bonds, and forex, they carry significant market influence and are usually touted as the whales of the stock market.Example of an institutional investor
The following example can help you better understand what an institutional investor is. A mutual fund house is a common example of an institutional investor. When a fund house launches a new mutual fund scheme, it attracts investors who wish to invest in the fund. The pooled funds from individual investors are invested into different types of market securities depending on the investment objective and asset allocation strategy outlined by the fund manager. As an institutional investor, the MF fund house aims to invest on behalf of its investors and generate profits for them.Key Takeaways
- An institutional investor is an organisation or a company that invests pooled funds on behalf of its clients or members.
- Mutual funds, hedge funds, insurance companies, and venture capital funds are common examples of institutional investors.
- Institutional investors generally trade in large blocks of securities, commanding significant market influence.
- The buying and selling of large positions by institutional investors can significantly impact the price of securities.
- Institutional investors are generally considered more knowledgeable than regular retail investors and, therefore, privy to regulatory oversight.
Role of institutional investors
The chief role of an institutional investor is to buy, sell, and manage securities on behalf of its members, shareholders, or clients. Institutional investors are tasked with the responsibility to use their specialised knowledge and resources to find investment opportunities that may not be open to regular retail investors. By virtue of their enhanced market knowledge, institutional investors also face fewer regulations than regular investors. Since institutional investors conduct a high percentage of transactions on major exchanges, they can greatly impact demand and supply for securities, which, in turn, impacts their prices. In other words, the big trading volume of institutional investors can create imbalances in supply and demand and cause sudden price movements.Characteristics of institutional investors
Now that you are familiar with the meaning of institutional investors, it's time to understand some of their key characteristics:Substantial capital base
The pooling of funds from various entities allows institutional investors to have a substantial capital base. This substantial capital pool allows them to make significant investments across asset classes and markets.Professional management
Institutional investors deploy expert investment professionals to manage the pooled funds to champion the client’s financial interests. Experienced fund managers use analytical resources, market knowledge, and research to make informed financial decisions and generate profit for the investors.In-depth knowledge
Institutional investors tend to possess thorough market knowledge and resources that give them an edge over regular retail investors. These investors have more resources at their disposal to conduct thorough research, gather insights, and analyse data to make informed decisions.Extensive market influence
Institutional investors buy and sell in bulk, allowing them to alter the demand and supply for any market security. This grants them extensive market influence and a significant role in determining the price volatility of securities.Types of institutional investors
The different types of institutional investors are listed below:1. Mutual funds
Mutual funds are one of the most common types of institutional investors. Mutual fund schemes pool money from different investors and invest the sum in a diversified basket of securities. Retail investors with limited market understanding and knowledge generally prefer investing through mutual funds. The fund house appoints an expert fund manager to manage and invest the pooled funds. Fund managers allocate the investment according to the scheme's investment objective. Generally, MF schemes invest in a variety of assets to maximise diversification benefits and minimise investment risks.2. Hedge funds
A hedge fund is an investment partnership where money is pooled from members to invest in securities with the objective of earning positive returns. The pooled sum is managed by the fund manager, who is called the general partner. The group of investors are known as limited partners. Hedge funds operate like mutual funds but generally follow a more aggressive investment strategy and tend to be riskier. Given the higher risks involved, hedge funds tend to produce above-average returns for investors. Additionally, hedge funds also require a high minimum investment, making them exclusive options for wealthy investors.3. Insurance companies
Insurance companies are also institutional investors that invest the premiums collected from policyholders into various assets to generate returns. Since insurance companies collect premiums from a wide range of policyholders, the aggregated investment amount is quite substantial. The returns generated from institutional investing are used to pay policy claims.4. Endowment funds
Endowment funds are generally created by foundations or entities like schools, universities, colleges, hospitals, and other charitable organisations. Such funds are created with the objective of principal protection. The returns from the investment are used to finance the activities of the controlling organisation.5. Pension funds
Pension funds are another common type of institutional investor. Both employers and employees can invest in pension funds. The pooled funds are utilised to purchase various market securities and earn returns. As such, pension funds can be divided into two categories: the first, where the pensioner is entitled to a fixed pension, regardless of the fund’s performance and the second, where the pensioner’s pension depends on the fund’s performance.How do institutional investors invest?
According to the meaning of institutional investors, these investors pool money from their members and clients to invest on their behalf. Institutional investors use different strategies to invest. They generally spread investments across various asset classes like stocks, bonds, forex, real estate, and gold to diversify, optimise returns, and minimise risks. These investors have access to sophisticated analysis technologies and deploy expert professional managers with thorough market knowledge to ensure optimised capital allocation.Additionally, institutional investors make investments according to the interest of the actual investors. In other words, the asset allocation strategy matches the investors' interest. Their goal is to generate positive returns for investors. Institutional investors can also engage in active trading or participate in market segments, like the forward markets, which are inaccessible to retail investors.
Impact of institutional investors
Institutional investors carry a significant market impact potential due to their sizable market clout. These investors trade more sizable positions, both short and long, making up for a large proportion of the transactions happening on an exchange. This means that their trades have a significant impact on the demand and supply of securities and invariably impact their prices as well. This is why institutional investors are often called market markers. Institutional investors also play a key role in improving market efficiency and shaping corporate governance practices.Merits of institutional investors
Institutional investors are crucial for the following reasons:- Institutional investors are the primary source of capital for publicly traded companies.
- They help retail investors mobilise their capital and invest in certain avenues not open to general retail investors.
- Institutional investors are privy to specialised knowledge and have access to various analytical tools, allowing them to diversify their investments, maximise returns, and minimise loss potential.
Demerit of institutional investors
Despite these merits, institutional investors also come with the following demerits:- Institutional investors own a high percentage of ownership stake in publicly traded companies. If they decide to pull their investment from companies, it can result in financial instability for the company.
- These investors can pull out of other securities as well, resulting in a sudden change in the security’s price dynamics.
Difference between institutional investors and individual investors
The meaning of institutional investors becomes clearer when you understand the differences between institutional and individual investors. The following table sums up the differences between the two entities:| Parameter | Institutional Investor | Individual Investor |
| Definition | An institutional investor is a company or organisation that pools and invests funds on behalf of other investors. | An individual investor is a retail investor who invests and trades in securities through a brokerage firm. |
| Scope | Institutional investors can invest and trade in all types of securities across different markets. | Certain types of markets, like the swap and forward markets, are inaccessible to individual retail investors. |
| Influence | Institutional investors hold significant power to influence the demand and supply of securities and, thereby, affect price movements. | Individual investors do not hold enough power to influence the price movements directly. |
| Regulations | Institutional investors are generally subject to fewer protective regulations. | Individual investors are generally subjected to more protective regulations. |
| Trading volumes | Institutional investors generally buy and sell securities in block trades of 10,000 shares or more. | Individual investors generally buy and sell securities in smaller lots of close to 100 shares. |
Conclusion
Institutional investors manage large capital pools and invest on the behalf of their members and clients to maximise returns. These investors play a key role in price determination in the securities market, given the hefty positions they hold. Given their superior market expertise and influential market marker position, institutional investors are privy to certain exclusive market segments.Understanding the role and impact of institutional investors can help you better understand how mutual funds work. Once you’ve mastered that understanding, you can start investing in mutual funds through the Bajaj Finserv Mutual Fund Platform. This smart and intuitive platform allows you to compare mutual funds and invest in the best options online with just a few easy clicks. Moreover, you also have a free mutual fund calculator at your disposal to compute your potential returns and trim your financial plan accordingly.
