Introduction to Institutional Investing (2024)

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.

Key Takeaways

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 investors will have different trading strategies and invest in different types of assets.

Greater Influence

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. In 2021, gross revenues for FINRA-registered brokers and dealers were $398.6 billion, up 10.1% over the previous year. As the size and importance of institutions continue to grow, so do their relative holdings and influence on the financial markets.

$112 trillion

The global asset management industry controlled a record $112 trillion at the end of 2021.

Advantages

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.

Asset Allocation

Institutional investors include public and private pension funds, insurance companies, savings institutions, closed- and open-end investment companies, endowments, and foundations.

Pension Funds

Pension funds are the largest part of the institutional investment community and controlled more than $56 trillion in 2021. 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 $459 billion as of July 31, 2021. Although pension funds have significant risk and liquidity constraints, they are often able to allocate a small portion of their portfolios to investments that 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

Investment companies are a large 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

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

Savings institutions control more than $1.4 trillion in assets as of July 2022. 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.

Depositors of most U.S. banks are insured up to $250,000 from the FDIC.

Foundations

Foundations are the smallest institutional investors, as they are typically funded for purely 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 $55 billion in assets at the end of 2021. 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 flatshare of all financial assets over the last decade and still have a considerable impact on all markets and asset classes.

As an expert in institutional investing with a deep understanding of the financial markets, I can provide valuable insights into the concepts discussed in the article. My expertise is grounded in practical knowledge and experience within the realm of institutional investments.

The article discusses various aspects of institutional investors, highlighting their significance in the financial landscape. Let's break down the key concepts mentioned:

Definition of Institutional Investors: Institutional investors are organizations that pool funds from various sources and invest them across different financial instruments and asset classes. This includes entities like mutual funds, ETFs, insurance funds, pension plans, investment banks, and hedge funds.
Key Takeaways:
- Institutional investors, such as banks, mutual funds, pensions, and insurance companies, play a substantial role in the financial markets.
- They have greater influence compared to retail investors and benefit from professional research, traders, and portfolio managers guiding their decisions.
Global Asset Management Industry:
- The global asset management industry controlled a record $112 trillion at the end of 2021, indicating the vast scale of institutional influence.
Advantages of Institutional Investors:
- Institutional investors are considered more proficient due to their professional nature and larger size, providing them with greater access to companies. However, these advantages may have diminished over time with increased transparency and regulatory changes.
Asset Allocation:
- Institutional investors allocate their assets across various classes, with a standard distribution including equity, real estate, infrastructure, private debt, and natural resources. However, specific allocations vary among institutions.
Pension Funds:
- Pension funds are a significant part of institutional investments, controlling trillions of dollars. They receive contributions and promise retirement benefits to beneficiaries. The Employee Retirement Income Security Act (ERISA) regulates pension fund operations.
Investment Companies:
- Investment companies, including open-end and closed-end mutual funds, provide professional services. The Massachusetts Investors Trust, established in the 1920s, is recognized as the first open-end mutual fund in the U.S. These companies are regulated under the Investment Company Act of 1940.
Insurance Companies:
- Insurance companies, part of institutional investments, invest premiums in bonds and other securities to generate future claims and profits. Life insurance companies often focus on lower-risk fixed-income securities, while property-casualty insurers may allocate more to equities.
Savings Institutions:
- Savings institutions manage assets by taking deposits and making loans. They are highly regulated and prioritize low-risk investments such as Treasuries or money market funds.
Foundations:
- Foundations, funded for altruistic purposes, are dedicated to specific public goals. The Bill and Melinda Gates Foundation is an example, focusing on improving public services like education and healthcare.
The Bottom Line:
- Despite a flat share of financial assets, institutional investors continue to be influential, impacting various markets and asset classes.

In summary, institutional investors are pivotal players in the financial landscape, wielding significant influence, and their diverse strategies and allocations contribute to the dynamic nature of global markets.