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 investor will have different trading strategies and invest in different types of asset.
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. Institutional investors own about 80% of equity market capitalization. As the size and importance of institutions continue to grow, so do their relative holdings and influence on the financial markets.
The North American asset management industry controlled more than $88.5 trillion at the end of 2017, according to McKinsey estimates.
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 2017 report on the industry is approximately 40% of assets to equity and 40% to fixed income. Another 20% of total assets were allocated to alternative investments like real estate, private equity, hedge funds, cash, and other areas. However, these figures drastically vary from institution to institution. Equities have experienced the fastest growth over the last generation, and 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 $41 trillion in early 2018. 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 $390 billion at as June 7, 2020. Although pension funds have significant risk and liquidity constraints, they are often able to allocate a small portion of their portfolios to investments which 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 the second largest 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 trillion in assets as of December 2019. 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.
Foundations are the smallest institutional investors, as they are typically funded for pure 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 $51 billion in assets at the end of 2019. 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 flat share of all financial assets over the last decade and still have a considerable impact on all markets and asset classes.