What are Institutional Investors?

Tuesday, October 30, 2018 | MarketBeat Staff
What are Institutional Investors?

If you’re really wondering what moves the price of individual securities, you have to look at two things – volume and buying power. For a stock to move in price, it requires the purchase of a large volume of shares. Few, if any, individual investors have the means to purchase that many shares through a broker. Still, many investors are left behind as markets move. The reason for that is a group of investors known as institutional investors.

Institutional investors are the investors who move markets for good and for bad. These are the investors that tend to lead markets into and out of bear and bull markets. In this article, we'll define institutional investors and we'll review the impact they have on the market.

What are institutional investors?

Institutional investors are large firms that buy and sell securities and make other investment decisions, on behalf of individual members or shareholders. If you own a mutual fund or participate in an employer-sponsored retirement or pension plan, your investments are being "managed" by institutional investors.

Some of the most common institutional investors are:

Pension funds– This group includes a lot of state and federal investment boards.

Mutual funds– Although we typically think of mutual funds as being for individual investors, there are actually different classes of mutual funds including some that are exclusive to institutional investors. These funds have minimum investment requirements and other restrictions that make them inaccessible to individual investors.

Money managers – These are individuals or financial firms that manage the portfolios of individual or institutional investors. Money managers receive a fee for their services and in exchange for this fee; the money manager has a fiduciary duty to make investment decisions that are in the best interest of their clients. A money manager is sometimes referred to as a “portfolio manager” or “investment manager”.

Insurance companies– Investing is crucial to the stability of underlying insurance products such as annuities.

Investment banks – An investment bank is not a “bank” in a traditional sense. These are private companies that perform activities such as acting in their client’s agents in raising capital.

Other categories of institutional investors include commercial trusts, endowment funds, and hedge funds/hedge fund investors.

How are institutional investors different from individual investors?

There are several differences between institutional and individual investors that go beyond their sheer size. For starters, they have access to investment vehicles like swaps and forward markets that are generally closed to retail investors. The way they purchase shares is also different. Individual investors (also known as retail investors) are limited to purchases of 100 shares or more in what is referred to as round lots. Institutional investors, by contrast, can trade up to 10,000 shares in block trades. Also, whereas individual investors typically make their trades, particularly large trades, through a broker for a fee, institutional investors make trades through directly through the exchange that they are trading on or through an intermediary for a negotiated price. Another important distinction between individual investors and institutional investors is that institutional investors do not typically invest money that they raise themselves. Rather, they generally invest money for other people or groups.

Beyond the actual mechanics of how they trade and the difference in the quantity of money available to them, institutional investors have access to research and intelligence that retail investors do not. While individual traders have access to trading software that can assist in technical analysis, institutional investors have access to company information that is essential to fundamental analysis. This fundamental analysis can allow them to spot stocks that may be undervalued.

Because they have access to this information and research, institutional investors are generally seen as being “in the know” more than individual investors which means that they are also presumed to know what they’re doing. This assumption of competence allows institutional investors to trade without the same Securities & Exchange Commission (SEC) regulations that private investors are subject to.

What impact do institutional investors have on markets?

The two things that really move the price of a security is high volume and sustained buying power. Both of these are the strength of institutional investors. To begin with, they are the largest force that affects supply and demand. In fact, institutional investors make up 50% of the volume on the New York Stock Exchange. Because institutional investors perform the majority of trades, they have great influence over the price of securities.

This is because institutional investors have the purchasing power to buy large quantities of shares. Individual securities that are trading at a volume of 400,000 or less are considered to be “thinly traded”. Such securities will not garner interest from institutional investors because they are looking to buy in large quantities.

In some cases, institutional investors are investing in corporations because they want to take an active role in the management of the company. However, in many cases, they only desire a passive role.

Can individual investors profit from institutional investors?

In some cases, individual investors catch a price movement in a stock well after institutional investors have gone on their buying spree. This means that they are buying when a security is nearing a top, and perhaps getting ready for a correction. In fact, some individual investors will actively look for securities that are not being bought by institutional investors with the hope that they can buy a stock at a discount and profit when the institutional money starts rolling in.

On the other hand, the price movements that come from institutional investors do not happen in a day. Price movements may take weeks, even months to fully materialize. There's a reason for this. Every time an institutional investor buys a large number of shares, the price of the security goes up. If they were to buy hundreds of thousands, or millions, of shares in a single day, they would start to drive the price up to a point where they would no longer be affordable.

So instead, they take a measured approach. They buy a little at a time and allow the market to digest the increased price before buying more. This is the time when individual investors can jump in and ride the wave as it goes up.

Another thing to remember about institutional investors is that they have to report their performance results on a regular basis. This can lead to a practice known as "window dressing" in which in the run-up to the reporting period, they look to buy stocks that are ascending and sell stocks that are descending. This can cause their portfolio to take on a lot of volatility at the end of a quarter. However, in the midst of this volatility, individual investors can find opportunities to profit.

However, in addition to window dressing, institutional investors are also known to talk stocks up or down. A well-timed TV or radio interview can send a stock moving in a particular direction, often to the benefit of the institutional investor. In the same way, analysts can issue a buy or sell rating for the same reasons. In either of these cases, retail investors need to be careful that there is still positive momentum for the stock they are considering investing in. 

If a company is publicly traded, retail investors can find if a particular security is being supported by institutional investors by checking with the investor relations department. They will be able to provide a list of the institutional investors that are currently invested.

The bottom line on institutional investors

There are two types of investors, individual (or retail) investors and institutional investors. Institutional investors operate as a proxy for individual member or shareholders of a company by making investment decisions on their behalf. Pension funds, mutual funds, money managers, insurance companies, and investment banks are among the most common types of institutional investors.

Institutional investors are different from retail investors in their buying power because they have more access to capital. They can also engage in specific trading techniques like swap options that retail investors are usually shut out of. Also, institutional investors generally have access to a large amount of information that retail investors do not have access to. This gives institutional investors an assumption of competence that allows their trading to be conducted without the same SEC scrutiny that retail investors must endure.

Institutional investors are important to the market if for no other reason than they constitute over 50% of the trading volume on the New York Stock Exchange. They play an integral role in the supply and demand dynamic that drives security prices upward. Institutions will only be investing in securities that have a high trading volume (over 400,000 shares per day).

Although institutional investors have a great deal of purchasing power in the market, it can still take time for their actions to take a share price where they want it. One of the reasons for this is that because they can only make purchases one block at a time, by the time they would purchase the volume they desired, the short-term price movement would put the stock out of reach. For this reason, these investors tend to take a more measured approach. This gives retail investors an opportunity to profit as they notice institutional dollars flowing into a particular stock. Retail investors can find out if a particular stock price’s climb is due to institutional dollars through the investor relations department of a company.

Two common practices that individual investors engage in that could be both profitable or detrimental to retail investors are window dressing and talking stocks up or down. Before they submit a quarterly report, institutions will try to make sure they buy their winners and sell their losers. In the same way, institutions may give interviews that talk up or talk down individual stocks in hopes that the price movement will go their way.




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