The financial market represents a dynamic and ever-evolving landscape. As a result, there are numerous ways for individuals and businesses to leverage potentially lucrative opportunities. It also stands to reason that the types of investors will vary in accordance with what it is that they are trying to achieve. Institutional investors represent a sizeable portion of the marketplace, and they serve several important roles.
What defines this type of investor? What are their primary characteristics, and how can they sometimes impact predominant market conditions? It is wise to address these and other questions to better appreciate why institutional stock trading has grown exponentially in recent times.
Institutional investing at a glance: The fundamental principles
Institutional investors are entities that deal with multiple stakeholders. These institutions will then pool the financial capital from individuals together in order to develop a diversified asset portfolio. Such a strategy will often benefit their clients, as the funds are allocated to various different investments. Thus, the levels of inherent risk may be lessened when compared to one-off trades (such as a large holding in a blue-chip company).
Institutional asset management is also unique in the fact that the entities themselves provide a greater degree of solvency and creditworthiness. This is not always the case when compared to retail or individual investors. Clients and traders can therefore remain confident that their investments are in good hands. Furthermore, institutional investment firms boast a substantial amount of industry knowledge. They employ a number of experts in various fields, providing levels of insight that traditional traders may not be able to access.
What types of entities may become involved with institutional stock trading?
First and foremost, institutional investors are legal corporations that have been vetted by the appropriate governmental authorities. This is important for reasons of transparency and compliance. However, the exact type of financial institution can vary. As this article highlights, these firms can be broken down into several categories, including (but not necessarily limited to):
- Banks and building societies.
- Insurance companies and pension funds.
- Firms specialising in mutual funds.
- Hedge funds.
- Endowments.
The main takeaway point is that these institutions possess the capital that is required to become involved with larger and more diversified trading strategies. This also leads directly into the next main point.
A closer look at institutional investment strategies
There are many ways in which an institutional investor will approach a potential opportunity. It can be argued that the most important method is to appreciate the needs of its client base. Simply stated, the firm will offer assets and investments that are in accordance with its customers. This is why some specialise in high-yield stocks while others are more concerned with longitudinal growth (such as is often the case with pension funds).
Another important observation involves the number of investment funds that are monitored at any given time. As firms need to develop a well-balanced portfolio, multiple funds must be governed simultaneously. This is why professional advisory firms will leverage the talents of highly trained professionals so that nothing is left to chance.
A portion of any institutional investment strategy likewise involves risk assessment. However, it is impossible to remove the risks associated with any type of investment. The primary intention is, therefore, to mitigate the impact of any unforeseen circumstances. Some of the potential associated with institutional asset management can include:
- Failure to comply with the rights of shareholders.
- Falling short of transparency guidelines (such as those associated with the GDPR framework).
- Internal issues such as a poor management structure or a lack of cross-departmental accountability.
- Incorrect predictions in regard to assets and/or general market movements.
Thus, a considerable portion of any institutional investment strategy will centre around risk assessment. There are even times when an entire department within an investment firm will solely specialise in risk management.
Institutional investors versus retail investors
Now that a circumspect understanding of institutional asset management has been obtained, it is prudent to look at some additional lesser-known disparities between this approach and its retail counterpart.
One interesting observation involves the scope of assets that an institutional investment firm can acquire. They are often able to become involved in a host of different markets. Retail-side investors will not normally be able to access certain sectors such as forward markets and swaps.
Furthermore, these investment firms may have the ability to obtain information that is not available to the general public. This data can then be used to inform institutional clients of current and future opportunities. Such a fiscal “edge” will often generate a much higher ROI while still keeping levels of inherent risk relatively low.
A final difference between these two types of investors involves the size of the trades themselves. As retail investors are often influenced by limited amounts of working capital, some opportunities may be inaccessible. On the contrary, institutional investors can leverage the liquidity of pooled funds. This enables them to meet the minimum requirements of larger positions.
The impacts of institutional investors on the financial markets
It should now be clear that institutional investors are extremely important within the global financial community. As the Corporate Finance Institute highlights, this is why they are sometimes referred to as “market makers”. What type of influence will these entities exert?
It is first prudent to take into account the size of institutional transactions. These often represent a significant portion of financial transactions within a specific marketplace. This is one of the reasons why selling or buying a discrete asset can have a pronounced influence on its price (and, therefore, how it is ultimately perceived by individual and retail investors).
Institutional investors are also capable of dramatically influencing supply and demand. For instance, let us assume for a moment that a hedge fund purchases the majority of shares in a certain firm. This lack of supply may lead to an increase in demand, and once again, this will normally cause the value of the asset in question to rise. However, it should be noted that a sudden asset liquidation could cause the market price of a share to dramatically plummet. This can sometimes lead to a negative outcome (such as a position that cannot be liquidated due to a lack of buyers).
These types of financial institutions are also viewed as being beneficial to the economy as a whole. This primarily arises from their ability to inject large amounts of capital into the marketplace from time to time. Also, institutional clients will be provided with access to opportunities that would not be possible when dealing with more traditional investment strategies.
A final influence that institutional investors exert over the financial markets involves how others interpret their actions. As institutional firms are often privy to sensitive information, their strategies are often followed by retail investors. While this may not be advised by experts, it still occurs on a regular basis.
Institutional investors: An undeniable influence within the modern financial community
Interestingly enough, many industry experts can trace the roots of modern institutional investing back to 1946, when the first venture capital firms were created. Since this time, these entities have had a massive impact on the markets. Whether referring to a bullish climate or a bearish outlook, the fact of the matter is that institutional asset management is always present behind the scenes.
As more individuals become involved in the financial markets, it is a foregone conclusion that the demand for reputable institutional investment firms will continue to rise. It will indeed be interesting to witness what the future may have in store.
