In the world of finance, institutional investors are a powerful force. They dictate supply and demand in the marketplace and play a key role in how securities are priced. It therefore pays to learn about this diverse group of actors and what motivates them.
Although the name might imply otherwise, institutional investors are not individuals but rather nonbank organizations that buy and sell securities on behalf of their members. They trade securities in large enough quantities to qualify for preferential treatment and lower commissions, which makes them the primary point of contact for individuals looking to invest in the market.
In general, there are six types of institutional investors:
- Mutual funds
- Hedge funds
- Pension funds
- Endowment funds
- Insurance companies
- Commercial banks
Although they differ in scope, most institutional investors are governed by the U.S. Securities and Exchange Commission (SEC) and must file a Form 13F with the federal agency to report quarterly holdings. Institutional investors must also file Form 13G if they own 5% or more of a company’s stock.
Due to their size, institutional investors have several resources at their disposal to help them decide whether to invest in a particular company, asset or industry. These firms have the resources to conduct in-depth research and acquire highly specialized analytics tools to evaluate entire markets. For this reason, institutions have a considerable advantage over the retail investor, i.e., the non-professional investor who buys and sells securities through traditional or online brokerage firms.
Due to the size of their holdings, institutions exert the largest impact on the financial markets. In fact, the vast majority of trading on major exchanges is carried out by institutional investors. Therefore, institutional trading activity is said to have a large impact on the price of a particular security or asset.
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Types of Institutional Investors
In the following section, we will provide an overview of the six types of institutional investors, including examples of each.
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Mutual funds are perhaps the most well-known class of institutional investor. A mutual fund is essentially an open-ended investment firm that pools money from individual investors into one fund controlled by a portfolio manager. Investments may include stocks, bonds, futures, currencies and virtually any other type of security. Some of the most popular mutual funds include the Fidelity Contrafund (FCNTX), American Funds Growth Fund of of America (AGTHX) and the Vanguard 500 Index Fund (VFINX).
Hedge funds are a class of alternative investments that use pooled funds to generate above-market returns. The organization usually consists of a limited partnership of investors that utilizes high-risk methods to generate large capital gains. In general, hedge funds are only available to accredited investors, as defined by the SEC. BlackRock is one of the most well known hedge funds.
Pension funds are a broad investment category that pay for employee retirement commitments. They typically allocate a portion of an employee’s monthly salary into a retirement portfolio, with contributions made by employees, employers or or both. There are generally two types of pension funds: the defined benefit fund and the defined contribution fund. California State Teachers’ Retirement System and Ontario Teachers’ Pension Plan are two of the biggest pension funds, operating in the U.S. and Canada respectively.
An endowment fund is a type of investment set up by a foundation that withdraws money from invested capital. Endowment funds are typically used by universities, religious institutes and other nonprofit organizations to advance their cause or operating process. Contributions to these entities are typically made via donations. For instance, Harvard University operates one of the largest academic endowment funds in the world.
An insurance company provides individuals and organizations with coverage against all forms of losses, including damages, injury, treatment or hardship, in exchange for a premium payment. AXA and Zurich Insurance Group are two of the world’s largest insurance companies.
Commercial banks are financial institutions that offer banking, lending and investment services to the general public. In the United States, commercial banks are insured by the Federal Deposit Insurance Corp. JPMorgan Chase and Bank of America are two of the biggest banks operating from the U.S.
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The Bottom Line
Institutional investors will continue to play a vital role in the financial markets as individuals place a premium on competent management and specialized knowledge. As the previous discussion illustrated, institutions are the single biggest driving force in securities trading.
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