What is an Institutional Investor?
An institutional investor is a legal entity that accumulates the funds of numerous investors (which may be private investors or other legal entities) to invest in various financial instruments and profit from the process. In other words, an institutional investor is an organization that invests on behalf of its members.
- Institutional investors are legal entities that participate in trading in the financial markets.
- Institutional investors include the following organizations: credit unions, banks, large funds such as a mutual or hedge fund, venture capital funds, insurance companies, and pension funds.
- Institutional investors exert a significant influence on the market, both in a positive and negative way.
Types of Institutional Investors
There are several types of institutional investors, such as:
- Credit unions
- Pension funds
- Insurance companies
- Hedge funds
- Venture capital funds
- Mutual funds
- Real estate investment trusts
Institutional investors are entitled to preferential treatment and lower fees. They are also subject to fewer protective rules because they are more qualified traders than individuals and thus better able to protect themselves.
Impact of Institutional Investors
Often called market makers, institutional investors exert a large influence on the price dynamics of different financial instruments.
The presence of large financial groups in the market creates a positive effect on overall economic conditions. The institutional investors’ activism as shareholders is thought to improve corporate governance because the monitoring of financial markets benefits all shareholders.
In addition, institutional investors can access and know how to explore a variety of investment instruments not available for private investors.
Characteristics of Institutional Investors
The characteristics of institutional investors are the following:
- It is always a legal entity, and it is important to understand that an institutional investor is an enterprise managing a fund (e.g., a mutual fund), but not the mutual fund itself.
- The basis of an institutional investor’s activity is professional, and it manages assets based on the interests and goals of its clients.
- An institutional investor always manages a significant number of funds.
Individual Investors vs Institutional Investors
An individual can invest in any assets that are available to them on the exchange. An institutional investor can also buy assets but is oriented more on long-term investing.
Institutional investors also access large operational activities due to corporate opportunities. With substantial capital and licensing, large institutions secure access to many assets that are not available to private individuals.
They include foreign securities, government business loans, changed banking policies, interest rates, and more. If individuals work as retail investors, institutional investors are more likely to conduct wholesale purchases.
Risks in Institutional Investing
Understanding the risks that institutional investors face is very important. Their problems can be classified as follows:
- Permanent risks of non-compliance with the legal rights of shareholders. They include a lack of qualified, experienced appraisers and a lack of a clear and well-established policy on the payments of dividends.
- Problems with the work organization of management structure and officials. The employment of managers and analysts is formal, and there is no model for determining the quality of their work. Such problems are also present in other divisions, such as top management or marketing.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: