ROLE OF INSTITUTIONAL INVESTORS IN FINANCIAL MARKETS: Meaning of institutional investors, features of institutional investors, Types of institutional investors and role of institutional investors in financial markets.
INSTITUTIONAL INVESTORS
Institutional investors are legal entities that participate in trading in the financial markets .
These constitute a segment of investors who are capable of buying or selling on a large scale in the stock exchange market. They buy and sell through brokers, sub-brokers, portfolio consultants etc.
In India, major institutional investors include life insurance corporation of India, General Insurance Corporation, Unit Trust of India, Building Societies, Charitable Trusts and Religious Organizations.
“The institutional investors have emerged as the most important group of investors in corporate securities” I agree with this statement.
Institutional investors exert a significant influence on the market in a both positive and negative way.
Often known as market makers, institutional investors exert a large influence on the price dynamics of different financial instruments.
The presence of large financial groups in the market creates a positive effect on overall economic conditions. The institutional investors activism as the shareholders is thought to improve corporate governance because of the monitoring of financial markets benefits all shareholders.
FEATURES OF INSTITUTIONAL INVESTORS
- It is always a legal entity and it is important to understand that an institutional investor is an enterprise managing a fund, but not a mutual fund itself.
- The basis of institutional investor’s activity is professional, and it manages assets based on the interests and goals of its clients.
- An institutional investor always manages a significant number of funds
TYPES OF INSTITUTIONAL INVESTORS
There are several types of institutional investors:
Some of them are explained as follows:
- MUTUAL FUNDS: It is the most popular institutional investor. Mutual funds are vehicles facilitating investment in a variety of securities with capital commitment from several investors, both individual and otherwise.
In other words, numerous entities invest their capital, which is pooled and in turn, invested in a bag of securities called mutual funds. Thus, individuals with understanding of stock market dynamics can rely on this instrument to mobilise their disposable income. MF is designed to minimize the risk of capital loss, wherein the gain from one dilute loss in another security kind.
2. HEDGE FUNDS: Hedge funds are investment partnership where money is collected from members is pooled to invest in securities. Fund manager of hedge funds is called General partner and group of investors is called limited partners. These funds are designed to reduce risk and enhance returns via a diverse portfolio.
3. INSURANCE COMPANIES: Insurance companies are heavy weight institutional investors. These institutions employ the premium they receive from policyholders into securities. Since the aggregate of premiums is considerable, their investments are also sizable. The returns insurance companies receive from trading are deployed to pay for claims.
4. ENDOWMENT FUNDS: Endowment funds are set up by foundations, where the administrative entity utilizes the funds for its cause. Typically, schools, universities, hospitals, charitable organizations etc. establish these funds. Here, the investment usually acts as a deductible for the investor. These funds are so designed that the principal remains intact, and the controlling organization uses the investment income to finance its activities.
5. PENSION FUNDS: Here, both employer and an employee can invest in pension funds. The accumulated capital goes toward the purchase of different kinds of securities.
There are two kinds of pension funds:
- Where pensioner receives a fixed sum irrespective of how the fund fares.
- Where pensioner receives returns based on the performance of the fund.
ROLE OF INSTITUTIONAL INVESTORS IN FINANCIAL MARKETS
- INSTITUTIONAL INVESTSORS INFLUENCE CORPORATE GOVERENCE TO INCREASE PROFITABILITY: Institutional investors, with their enormous wealth and ownership of majority of stocks a firm can influence and yield power over corporate governance. There are also institutional investors who seek to influence control in the management of the company to improve profitability and this phenomenon is known as shareholder activism.
- PLAY AS KEY FACTOR IN REDUCING INFORMATION ASYMMETRIES: In a financial market, information is of paramount importance. Institutional investors with their large capital usually seek and demand the right information from the firms selling share of stocks. Firms on the other hand in reaction to the demands of the institutional investors, they want to attract to their company, provide organized and comprehensive financial information to the public, usually by employing information intermediaries to perform the specific role. In this way, large, complex and incongruent information that are circulated in the financial world is reconciled, thereby reducing the flow of asymmetrical information and attracting more investors.
- AS FINANCIAL INTERMEDIARIES: Numerous institutional investors act as intermediaries between lenders and borrowers. As such, they have a critical importance in the functioning of the financial markets. Economies of scale imply that they increase returns on investments and diminish the cost of capital for entrepreneurs. Acting as saving pools, they also play a critical role in guaranteeing a sufficient diversification of the investor’s portfolios. Their greater ability to monitor corporate behavior as well to select investor’s profiles implies that they help agency costs.
- DOMINATES THE SECURITIES MARKETS: Institutional investors have led to the emergence of an investment culture wherein investment has become part of life style of many people. One social implication of the growth is the relative importance of institutional investments is the disappearance of difference between workers and owners. In aggregate, the workers own the companies for which they work. It is not the direct ownership of the specific companies for which they work. Each worker through right in pension funds, life assurance policies and other institutional investments owns a slice of the aggregate of firms that have issued shares.
- ARE CRITICAL INDICATORS OF STOCK MARKET: In the stock market, institutional investor’s buying and selling behavior is watched critically by individual stock traders, brokers and other institutional investors. Their market behavior is used as an indicator of the health of the market, the firm and the stock price. With the institutional investor’s wealth and knowledge and their considerable number of shares in the firm, their buying and selling behavior have a significant effect on the valuation of the stock. Stocks that are brought by them are considered good and profitable stocks.
- AFFECTS THE FIRM’S LIQUIDITY: Institutional investors affects the firm’s liquidity. Firms with considerable assets that can be easily converted into cash are likely to attract institutional investors in the same way that the ownership of institutional investors of a large amount of shares of a firm implies liquidity of the firm’s assets. Big or small investors are attracted to firms that have more liquidity because it is easier for them to buy and get out of the market quickly.
- INSTITUTIONAL INVESTORS AND PRIVATE EQUITY: Institutional investors can have an importance in providing finance for young business beyond the provisions of collective investments such as venture capital trusts. The main institutional investors are pension funds, insurance companies and mutual funds such as unit trusts, open end investment companies and investment trusts and hedge funds. Institutional investors may own private equity firms, which are firms that buy the shares of new or small businesses even through the shares are not traded on stock exchange. Money invested in such companies are often described as private equity.
Private equity firms become co-owner of the companies in which they invest and take an active managerial role in the companies with the expectations that the share will eventually to be sold to another private equity firm or to another firm that makes a take over bid or through the stock exchange when the shares are accepted for stock exchange listing.
CONCLUSION: Institutional investors are important to financial markets, because they bring a huge amount of investments to the firm which is necessary for capitalization. The presence of institutional investors in the firm has a profound and positive implication on the financial health of the firm whether perceived or real and a positive influence on the price of the stock. In many ways institutional investors affects stock market liquidity and volatility and influence the management and operations of the firm.
| ALSO STUDY: |
| Depositories act 1996 pdf |