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What is an Institutional Investor?

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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 22 August 2016
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An institutional investor (II) is a large entity with access to a substantial pool of funds used for investments. Institutional investors make investments on behalf of others, and they are a major force in the market, accounting for over 70% of the trades on any given day in most financial markets. A closely related concept is a foreign institutional investor (FII), an entity which makes investments in a foreign financial market, as in the case of a British institutional investor investing in India.

Investment banks, brokerage houses, mutual funds, insurance companies, college endowment funds, pension funds, and hedge funds are all examples of institutional investors. These organizations pool financial contributions from large numbers of people, making investments in the market on behalf of the people who have contributed to the fund. For example, a pension fund collects contributions from employees and union members and invests them together. Investment choices are dictated by employees of the investment firm, and these employees use a variety of skills to determine how and when funds should be invested.

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The advantage to having access to substantial financial backing is that an institutional investor can create a very diverse portfolio, which will strengthen its financial position. Because these investors deal in large amounts of money, they also receive preferential treatment and can be eligible for special rates which are not made available to members of the general public. Institutional investors can also have a tremendous influence on the market and the solvency of individual companies because they wield so much financial power.

Financial regulations are applied differently to institutional investors than they are to other players in the market. As a general rule, they are subject to less regulation, and they are not as protected as consumers are. Regulatory protections are deemed less necessary because institutional investors are supposed to police themselves and manage their investments wisely, although this approach to regulation has not necessarily been embraced by everyone concerned with financial markets.

For people who are not experienced in the market, working with an institutional investor can generate a better return on investments than investing independently. Institutional investors protect their customers from the vagaries of the market, and can sometimes generate very high returns. However, lack of control over investments also means that consumers will not be able to shape the direction of their investments, and this could expose them to risks if the firms which invest on their behalf fail to identify market trends.

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miriam98
Post 4

@NathanG - Well, that was then, this is now. You are right – they did learn from those lessons, and nowadays institutional investors just tell it like it is. So there is still some safety in going with the large brokerage houses.

Another way to benefit from institutional investors is to watch their behavior. If you are in independent investor and see a stock price suddenly rise, find out why.

If you discover that there is heavy institutional buying, then you can buy with some confidence too, even if you don’t have an account with the institution. Just watch what they do, and you can learn a lot.

NathanG
Post 3

@indemnifyme - I do believe that the idea of safety with an institutional investor is a sound one, but even they are not perfect.

We should all remember that one of the lessons that all investors learned from the Internet bubble of the 1990s was that everyone can get swept away with the hype.

Institutional investors did their homework, but many of them felt pressured never to issue a “sell” order on any stock. This was despite the fact that some of these stocks needed to be sold off.

Some of these investment houses had cozy relationships with the companies they represented, and so the most that they could do was to issue a “hold” rating, and even that was done with some reluctance.

I remember watching the congressional investigations on television and seeing these stock analysts get hammered as to why they didn’t issue sell ratings on stocks they knew were overvalued. It wasn’t a pretty sight.

indemnifyme
Post 2

@starrynight - You're right. I think investing with an institutional investor is a good choice for a lot of people. Especially if you don't know much about the stock market.

I feel like for a seasoned investor the best way to go would be to invest some through an institutional investor and some on your own. You can take more risks if you're an individual investor which can result in more and great gains.

On the other hand, you can lose big too. That's why you should still do some of your investing through an institution!

starrynight
Post 1

As a consumer, I definitely feel more comfortable investing through an institutional investor than investing on my own. I feel like a large organization has a lot more knowledge and resources than little old me!

Plus, the article mentioned a ton of other advantages too, such as portfolio diversification. We all know the more diverse a portfolio, the better. Obviously the more funds you have, the more diverse you can make your portfolio. I know I can't generate as much funding as an organization that is investing for hundreds of people!

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