Institutional Investor: Definition, Process, and Types

Institutional Investor Definition
Institutional Investor Definition, Process, & Types

Institutional investors are large firms that invest money on behalf of others(clients) for higher returns. The group of institutional investors includes large organizations with professional analysts and commercial banks.

What is an Institutional Investor?

An institutional investor is a firm or organization that capitalizes money on behalf of other investors or entities. For example, institutional investors collect money from other individuals to invest in securities like bonds, stocks, forex, etc.

These institutions generally trade in large blocks and are called whales of Wall Street(stock market). As the trades are in large volumes, they usually create a sudden difference in the price of stocks or other securities.

Generally, retail traders buy stocks in smaller amounts, like 10-20, but institutional investors buy stocks in higher volumes, like 20,000 shares. These investors create a huge imbalance in demand and supply for a particular stock.

How to be an Institutional Investor?

Institutional Investors play a crucial role in strengthening the economy, and hence it is used as a parameter to decide the overall strength of the market. Institutional investors include entities like banks, insurance companies, hedge funds, and pension funds. An individual is considered an institutional investor if he is highly rich and buys securities in huge volumes. The other way to become an institutional investor is to be a part of organizations like hedge funds, banks, etc. Generally, institutional investors, after pooling huge amounts of money from various sources, provide the money to investment managers, who then invest the money in various assets. Institutional investors usually have large teams that conduct various analyses before investing.

How does Institutional Investing work?

Institutional investing is simply the process of investing the collected pool of money in various assets to get good returns. Examples of institutional investors include hedge funds, mutual funds, banks, and endowment funds.

The biggest advantage of institutional investors over retail investors is that they have the availability of huge amounts of data and analytics to help them invest in good-performing assets. It is also observed that institutional investors also use highly intelligent trading programs that automatically buy and sell stocks depending upon the changes in the stock prices.

Institutional investors generally have a huge team of experts with them so that they analyze every aspect of trading. These team members have highly qualified backgrounds in the field of finance and accounting. Sometimes, these investors even have contacts in the company’s management to get deeper information about the business.

Who are the Institutional investors?

Institutional investors are the organizations that serve their clients by giving them good returns by investing their money in various kinds of securities.

For example, The government of Singapore owns 32 stocks worth ₹90,000 crores on the Indian stock exchange. So this entity acts as an institutional investor in the Indian stock exchange. 

So, these investors generally trade large volumes of securities, unlike retail investors that trade in small magnitudes.

As these entities trade in large volumes, they might create an imbalance in the stock market, which would ultimately lead to drastic price differences.

What are the types of Institutional investors?

There are several kinds of institutional investors, and all of them are differentiated based on how they manage their assets depending on their client’s goals.

types of Institutional investors
What are the types of Institutional investors?

The following are the different types of institutional investors:

1. Insurance companies

Insurance companies are one of the biggest institutional investors. They invest the money they receive as a premium from its client. The profits they make after trading are used to give back claims to their clients.

2. Mutual funds

People that have narrowed knowledge about the stock market rely on this medium to get better returns. Mutual funds pool the capital from their customers and invest it in different securities. Mutual Funds are used to minimize the risk of capital loss.

3. Hedge funds

The characteristics of hedge funds are almost similar to mutual funds. But the investment policies in hedge funds are more fierce compared to mutual funds because of which hedge funds are riskier and generally have higher rates of return compared to mutual funds.

4. Commercial banks

These banks pool money from their customers in the form of savings, current accounts, fixed deposits, etc. They invest the collected funds in less risky investment options, which are then given back to the customers in the form of savings.

5. Pension funds

Pension funds are also one of the biggest institutional investors. In pension funds, both employer and employee invest their capital. The collected capital is then invested to buy various kinds of securities.

There are two types of pension funds:

  • In the first one, the individual gets a fixed amount of money.
  • In the second one, the individual receives returns depending upon the performance of the securities.

6. Endowment funds

In general, schools, universities, charitable organizations, etc. create endowment funds. Endowment funds are designed in a way such that the principal amount remains unaffected, and the returns from them are used by these organizations to fund their activities.

Where does the Institutional Investor invest in?

The main goal of institutional investors is to generate maximum profit for their clients in the fastest way possible. Institutional investors capitalize on various kinds of securities like bonds, stocks, forex, and foreign contracts.

  • Stocks: It is a kind of security that makes sure that the owner has some proportion of ownership in the issuing corporation.
  • Bonds: It is a kind of debt security, in which the company or the government is given a loan with the bonds. The investors are given a fixed rate of return over a particular time frame.
  • Forex: It stands for foreign exchange, in which the investors exchange foreign currencies to get better returns.

How do Institutional Investors earn profit?

Institution investors generally consist of mutual funds, private equity, and banks. These entities usually buy high volumes of stocks on behalf of their clients. These entities are usually welcomed by the companies as they buy shares in much larger magnitudes. These big investors invest the money collected through their clients, and they charge a small fee in return. 

As these investors are trading in higher volumes, for every successful trade, they get a higher percentage of profits. After distributing the profits to their clients, they save a good amount of money for their expansion and growth. 

Is it better to have an Institutional Investor than a Retail Investor?

Institutional investors are more reliable compared to retail investors as they generally have more experience and knowledge about the market. Usually, institutional investors have fewer restrictions as compared to individual investors. They have bigger teams headed by individuals that have a lot of experience in finance, because of which they analyze the market more efficiently.

Big investment firms even use highly powerful tools to analyze any kind of change in the market (like trading computer programs). Institutional investors are even charged lower fees as compared to individual investors. As big investors influence the market by their decisions, different regulations are made for both individual and institutional investors.

Because of all these advantages, retail investors lag behind institutional investors in terms of better decision-making in the market. Hence institutional investors are better compared to retail investors.

Is it profitable to be an Institutional Investor?

The main goal of institutional investors is to invest the clients’ money to get maximum returns as fast as possible.

When compared to individual investors, institutional investors generally have greater advantages, like having an experienced team. Just because institutional investors are trading larger volumes, they have access to institutional funds. Big Investors also have access to various kinds of vital analytics of various companies that help them to make profitable investments. Even the individuals working for these big investors are given huge salaries and benefits. Therefore, we say that institutional investors are profitable and earn sufficient money for their expansion and growth. 

What is the difference between Retail Investors and Institutional investors?

Below listed are the main differences between retail and institutional investors. 

  • Retail investors buy securities in lesser quantities, like 100 or more. Institutional investors buy shares in larger blocks(around 10,000 or more). Institutional investors generally buy shares of bigger companies to avoid sudden changes in the share price of small companies. Institutional investors avoid buying larger percentages of shares to avoid issues with securities laws.
  • Institutional investors also have an advantage of fees, Institutional investors charge a lesser amount of fees than individual investors.
  • Institutional investors also have an advantage over research and analytics as compared to individual investors. Institutional investors are generally more experienced and effective, because of which they create better returns for their clients.
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