Not all investors in the stock market are individuals who buy and sell their own hand-picked stocks and bonds. With the rise of mutual funds and index funds, institutional investors have become bigger players. Institutional investors are large funds made up of many individual investors. Pension funds are a prime example of an institutional investor. Read on to find out more about institutional investors and their role in the market.
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Institutional Investor Basics
If you buy your own stocks and bonds, you’re what’s known as a retail investor. If you buy shares in a mutual fund, you’re giving your money to an institutional investor. Mutual funds, hedge funds, pension funds, index funds, commercial banks, REITs, endowments and insurance companies are all institutional investors. They make investing decisions on behalf of individual members or shareholders.
The sizable presence of institutional investors in the market means that corporations that are ostensibly competitors have many of the same shareholders. If you look up the largest shareholders of brands you’re familiar with, you’ll find that institutional investors top many of those lists. Some institutional investors buy shares in a company with the intent of becoming vocal shareholders, while other institutional investors such as index funds are passive investors and do not take an interest in the running of the companies in which they invest.
How Institutional Investors Affect the Market
Most of the trading that happens on the market is done by institutional investors. By some estimates, institutional investors account for 70% of stock trading volume. The percentage of corporate shares held by institutional investors has increased dramatically in the last 60 years. Today, the volume of trades by retail investors pales in comparison to the trading activity of institutional investors.
To some analysts, the rise of institutional investors – particularly index funds – is a cause for concern. At a time when roughly 20% of stocks are owned by index funds, some say that all that indexing is distorting the market, and warn that, if index funds ever dominate the market, the economy could suffer.
Why? Because if passive investing dominates, the majority of stocks will no longer be bought on the basis of rewarding companies that are profitable, productive, promising and well managed. A traditional method of reward, punishment and incentive for companies will have broken down. Market mechanisms for determining the prices of commodities could also be distorted, these analysts argue.
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Next time you read about institutional investors in the business press you’ll understand what the term means. You can follow along as the debate over whether the rise of passive investing is hurting the economy unfolds. The chances are high that if you’re saving for retirement in a 401(k) or you’ve invested your nest egg, your money is being handled by an institutional investor. Retail investors who decide to buy and sell individual stocks are in the minority and often fail to achieve the results that index funds and other institutional investors achieve.
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