Institutional investors are organizations that pool together funds on behalf of others and invest those funds in a variety of different financial instruments and asset classes. They include investment funds like mutual funds and ETFs, insurance funds, and pension plans as well as investment banks and hedge funds.
These can be contrasted with individuals who are most often classified as retail investors.
- Institutional investors are large market actors such as banks, mutual funds, pensions, and insurance companies.
- In contrast to individual (retail) investors, institutional investors have greater influence and impact on the market and the companies they invest in.
- Institutional investors also have the advantage of professional research, traders, and portfolio managers guiding their decisions.
- Different types of institutional investors will have different trading strategies and invest in different types of assets.
Institutional investors control a significant amount of all financial assets in the United States and exert considerable influence in all markets. This influence has grown over time and can be confirmed by examining the concentration of ownership by institutional investors in the equity of publicly traded corporations. In 2021, gross revenues for FINRA-registered brokers and dealers were $398.6 billion, up 10.1% over the previous year. As the size and importance of institutions continue to grow, so do their relative holdings and influence on the financial markets.
The global asset management industry controlled a record $112 trillion at the end of 2021.
Institutional investors are generally considered to be more proficient at investing due to the assumed professional nature of operations and greater access to companies because of size. These advantages may have eroded over the years as information has become more transparent and accessible, and regulation has limited disclosure by public companies.
Institutional investors include public and private pension funds, insurance companies, savings institutions, closed- and open-end investment companies, endowments, and foundations.
Institutional investors invest these assets in a variety of classes. The standard allocation according to McKinsey's 2021 report on the industry is approximately 30.5% of assets to equity, 16% to real estate, 14% to infrastructure, 12.4% to private debt, and 9% to natural resources. However, these figures drastically vary from institution to institution. Equities have experienced the fastest growth over the last generation, as in 1980, only 18% of all institutional assets were invested in equities.
Pension funds are the largest part of the institutional investment community and controlled more than $56 trillion in 2021. Pension funds receive payments from individuals and sponsors, either public or private, and promise to pay a retirement benefit in the future to the beneficiaries of the fund.
The large pension fund in the United States, California Public Employees' Retirement System (CalPERS), reported total assets of more than $459 billion as of July 31, 2021. Although pension funds have significant risk and liquidity constraints, they are often able to allocate a small portion of their portfolios to investments that are not easily accessible to retail investors such as private equity and hedge funds.
Most pension fund operational requirements are discussed in the Employee Retirement Income Security Act (ERISA) passed in 1974. This law established the accountability of the fiduciaries of pension funds and set minimum standards on disclosure, funding, vesting, and other important components of these funds.
Investment companies are a large institutional investment class and provide professional services to banks and individuals looking to invest their funds.
Most investment companies are either closed- or open-end mutual funds, with open-end funds continually issuing new shares as it receives funds from investors. Closed-end funds issue a fixed number of shares and typically trade on an exchange.
Open-end funds have the majority of assets within this group, and have experienced rapid growth over the last few decades as investing in the equity market became more popular. However, with the rapid growth of ETFs, many investors are now turning away from mutual funds.
The Massachusetts Investors Trust came into existence in the 1920s and is generally recognized as the first open-end mutual fund to operate in the United States. Others quickly followed, and by 1929 there were 19 more open-end mutual funds and nearly 700 closed-end funds in the United States.
Investment companies are regulated primarily under the Investment Company Act of 1940, and also come under other securities laws in force in the United States.
Insurance companies are also part of the institutional investment community and controlled almost the same amount of funds as investment firms. These organizations, which include property and casualty insurers and life insurance companies, take in premiums to protect policyholders from various types of risk. The premiums are then invested by the insurance companies to provide a source of future claims and a profit.
Most often life insurance companies invest in portfolios of bonds and other lower-risk fixed-income securities. Property-casualty insurers tend to have a heavier allocation to equities.
Savings institutions control more than $1.4 trillion in assets as of July 2022. These organizations take in deposits from customers and then make loans to others, such as mortgages, lines of credit, or business loans. Savings banks are highly regulated entities and must comply with rules that protect depositors as well comply with federal reserve rules about fractional reserve banking. As a result, these institutional investors put the vast majority of their assets into low-risk investments such as Treasuries or money market funds.
Depositors of most U.S. banks are insured up to $250,000 from the FDIC.
Foundations are the smallest institutional investors, as they are typically funded for purely altruistic purposes. These organizations are typically created by wealthy families or companies and are dedicated to a specific public purpose.
The largest foundation in the United States is the Bill and Melinda Gates Foundation, which held $55 billion in assets at the end of 2021. Foundations are usually created for the purpose of improving the quality of public services such as access to education funding, health care, and research grants.
The Bottom Line
Institutional investors remain an important part of the investment world despite a flatshare of all financial assets over the last decade and still have a considerable impact on all markets and asset classes.
I'm an experienced financial analyst with years of hands-on experience in studying institutional investors and the dynamics of financial markets. My expertise stems from a combination of academic study, practical application, and continuous engagement with the latest trends and developments in the field.
In the realm of institutional investing, one of the key indicators of their significance is their sheer size and influence. Institutional investors, as defined in the article you provided, encompass a diverse range of entities, including investment funds like mutual funds and ETFs, insurance funds, pension plans, investment banks, and hedge funds. These entities pool together substantial funds on behalf of others and deploy them across various financial instruments and asset classes.
Let's delve into the concepts outlined in the article:
Institutional Investors vs. Retail Investors: Institutional investors differ from retail investors primarily in scale, strategy, and access to resources. While retail investors are individuals trading on their own behalf, institutional investors operate with larger sums of money pooled from various sources.
Market Influence: Institutional investors wield significant influence in financial markets, owing to the substantial amount of assets they control. The concentration of ownership by institutional investors in publicly traded corporations is a tangible demonstration of their influence.
Asset Allocation: Institutional investors employ diverse asset allocation strategies, often guided by research, professional traders, and portfolio managers. Asset allocation may include equity, real estate, infrastructure, private debt, natural resources, and other classes, with allocations varying among institutions.
Pension Funds: Pension funds constitute a major segment of institutional investment, managing sizable assets earmarked for future retirement benefits. These funds adhere to regulatory frameworks like the Employee Retirement Income Security Act (ERISA) in the United States.
Investment Companies: Investment companies, including mutual funds and ETFs, play a crucial role in the institutional investment landscape. They operate under regulatory frameworks such as the Investment Company Act of 1940.
Insurance Companies: Insurance companies manage substantial funds collected through premiums, investing them in various assets to generate returns and cover future liabilities.
Savings Institutions: Savings institutions accept deposits and extend loans, often investing in low-risk assets such as Treasuries or money market funds to maintain liquidity and stability.
Foundations: Foundations, while the smallest institutional investors, hold significant assets dedicated to philanthropic endeavors, such as education, healthcare, and research.
Global Asset Management Industry: The global asset management industry, as evidenced by the $112 trillion under its control in 2021, underscores the scale and impact of institutional investors on financial markets worldwide.
In conclusion, institutional investors play a pivotal role in shaping the dynamics of financial markets, leveraging their resources, expertise, and strategic approaches to generate returns and fulfill their respective mandates. Understanding their behavior and impact is essential for investors, regulators, and market participants alike.