Meet the Smart Money: What is an Institutional Investor?

Institutional investors are entities that have capital from either employees, investors, customers, or donors (depending on the nature of the organization) that the entity invests in an effort to grow, helping to ensure the entity’s future viability.

In general, there are six types of institutional investors: pension funds, endowment funds, insurance companies, commercial banks, mutual funds and hedge funds. They are the “smart money,” alongside market mavens, central banks, funds, and other financial professionals, who invest large amounts of capital with an edge on the little guy.

And they’re big.

According to the Financial Industry Regulatory Authority (FINRA), institutional investors controlled $25.3 trillion, or 17.4% of all U.S. financial assets as of the end of 2009. Since 1945, when these investors controlled must 5% of all U.S. corporate shares, their influence ballooned to 67% by 2010, and that trend has only continued from there.

It’s no exaggeration to say that institutions control the market as it exists today, and it’s up to the rest of us to adapt to the reality they’ve created.

Examples of Institutional Investors

  • Pension funds: Pension funds manage portfolios for pension money. Pension funds typically use a traditional investment strategy that splits assets between fixed-income investments, such as bonds, and equity investments, such as blue-chip dividend stocks, preferred stocks and commercial real estate.
  • Endowments: An endowment fund is typically funded by donations and established by a foundation for entities such as universities, nonprofit organizations, churches and hospitals. Endowment funds usually are set up in such a way that they allow the foundation to make consistent withdrawals (typically the income that the investment generates) to help the entity meet its operational needs and growth goals. An endowment fund essentially delays the use of a donation, employing it to help grow investment income to support the entity’s long-term viability.
  • Insurance companies: Insurance companies make their money based on their success assessing risk. As such, they invest primarily in bonds, which are considered the safest investment category. They also invest in stocks, mortgages and liquid short-term investments.
  • Commercial banks: While commercial banks make their money primarily from the interest they charge on loans to customers, along with bank fees, they also generate investment income by investing in stocks, along with other investments. In an effort to protect consumers, their investments are highly regulated to ensure that they don’t risk the loss of capital.
  • Mutual funds: Mutual funds are typically offered by banks as an investment product for consumers. A consumer chooses to invest money in a mutual fund, which the fund manager uses it to buy stocks, bonds and other securities.
  • Hedge funds: Hedge funds share a similar structure to that of mutual funds—using pooled money from investors. They, however, seek to achieve above average returns in both up and down markets. Hedge funds are considered to be riskier than other investments and are typically only open to accredited investors and other qualified individuals and organizations.

Institutional investors are sometimes called the “smart money” because they are just that. They have the benefit of capital that gives them the “leg-up” in the form of the ability to make well-researched decisions, the buying power to qualify for reduced fees, and the power of many brains working towards the same goal: capital growth for stakeholders.

Although institutional investors are bigger and “smarter” than the individual investor, however, they are not direct competition. Rather, they are just a different type of investor trying to make income on investments.