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Institutional investors

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Institutional investors

For the magazine, see Institutional Investor (magazine).

Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets. They can also include operating companies which decide to invest their profits to some degree in these types of assets.

Typical investors include banks, insurance companies, retirement or pension funds, hedge funds, investment advisors and mutual funds. Their role in the economy is to act as highly specialized investors on behalf of others. For instance, an ordinary person will have a pension from his employer. The employer gives that person's pension contributions to a fund. The fund will buy shares in a company, or some other financial product. Funds are useful because they will hold a broad portfolio of investments in many companies. This spreads risk, so if one company fails, it will be only a small part of the whole fund's investment.

An institutional investor can have some influence in the management of corporations because it will be entitled to exercise the voting rights in a company. Thus, it can actively engage in corporate governance. Furthermore, because institutional investors have the freedom to buy and sell shares, they can play a large part in which companies stay solvent, and which go under. Influencing the conduct of listed companies, and providing them with capital are all part of the job of investment management.

History

Ancient Rome and medieval Islam

Roman law ignored the concept of juristic person, yet at the time the practice of private evergetism (which dates to, at least, the 4th century BC in Greece) sometimes led to the creation of revenues-producing capital which may be interpreted as an early form of charitable institution. In some African colonies in particular, part of the city's entertainment was financed by the revenue generated by shops and baking-ovens originally offered by a wealthy benefactor.[1] In the South of Gaul, aqueducts were sometimes financed in a similar fashion.[2]

The legal principle of juristic person might have appeared with the rise of monasteries in the early centuries of Christianity. The concept then might have been adopted by the emerging Islamic law. The waqf (charitable institution) became a cornerstone of the financing of education, waterworks, welfare and even the construction of monuments.[3] Alongside some Christian monasteries[4] the waqfs created in the 10th century AD are amongst the longest standing charities in the world (see for instance the Imam Reza shrine).

Pre-industrial Europe

Following the spread of monasteries, almhouses and other hospitals, donating sometimes large sums of money to institutions became a common practice in medieval Western Europe. In the process, over the centuries those institutions acquired sizable estates and large fortunes in bullion. Following the collapse of the agrarian revenues, many of these institution moved away from rural real estate to concentrate on bonds emitted by the local sovereign (the shift dates back to the 15th century for Venice,[5] and the 17th century for France[6] and the Dutch Republic[7]). The importance of lay and religious institutional ownership in the pre-industrial European economy cannot be overstated, they commonly possessed 10 to 30% of a given region arable land.

In the 18th century, private investors pool their resources to pursue lottery tickets and tontine shares allowing them to spread risk and become some of the earliest speculative institutions known in the West.

Before 1980

Following several waves of dissolution (mostly during the Reformation and the Revolutionary period) the weight of the traditional charities in the economy collapsed; by 1800, institutions solely owned 2% of the arable land in England and Wales.[8] New types of institutions emerged (banks, insurance companies), yet despite some success stories, they failed to attract a large share of the public's savings and, for instance, by 1950, they owned only 7% of US equities and certainly even less in other countries.[9]

Overview

Because of their sophistication, institutional investors may often participate in private placements of securities, in which certain aspects of the securities laws may be inapplicable. For example, in the United States, a private placement under Rule 506 of Regulation D may be made to an "accredited investor" without registering the offering of securities with the U.S. Securities and Exchange Commission. In essence institutional investor, an accredited investor is defined in the rule as:

  • a bank, insurance company, registered investment company (generally speaking, a mutual fund), business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation, or partnership with assets exceeding $5 million;
  • a director, executive officer, or general partner of the company selling the securities;
  • a business in which all the equity owners are accredited investors;
  • a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase;
  • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
  • a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

Economic theory

By definition, institutional investors are opposed to individual actors on the financial markets. This specificity has majors consequences in the eyes of economic theory.

Institutional 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 savings pools, they also play a critical role in guaranteeing a sufficient diversification of the investors' portfolios. Their greater ability to monitor corporate behaviour as well to select investors profiles implies that they help diminish agency costs.

Life cycle

Institutional investors differ among each other but they all have in common the fact of not sharing the same life cycle as human beings. Unlike individuals, they do not have a phase of accumulation (active work life) followed by one of consumption (retirement), and they do not die. Here insurance companies differ from the rest of the institutional investors; as they cannot guess when they will have to repay their clients, they need highly liquid assets which reduces their investment opportunities. Others like pension funds can predict long ahead when they will have to repay their investors allowing them to invest in less liquid assets such as private equities, hedge funds or commodities. Finally, other institutions have an investment horizon extremely vast allowing them to invest in highly illiquid assets since they are unlikely to be forced to sell them before term. A famous example of this type of investors are US universities endowment funds.

Institutional-investor types

Globalization of financial markets

When considered from a strictly local standpoint, institutional investors are sometimes called foreign institutional investors (FIIs). This expression is mostly used in emerging markets such as Malaysia and India.

In countries like India, statutory agencies like the Securities and Exchange Board of India have prescribed norms to register FIIs and also to regulate such investments flowing in through FIIs. In 2008, FIIs represented the largest institution investment category, with an estimated US$ 751.14 billion.[10]

Regional

In various countries different types of institutional investors may be more important. In oil-exporting countries sovereign wealth funds are very important, while in developed countries, pension funds may be more important.

Japan

Japan is home to the world's largest pension fund (GPI) and is home to 63 of the top 300 pension funds worldwide (by Assets Under Management). These include:

  • Government Pension Investment ($1045.5 billion [2011])
  • Local Government Officials ($165 billion [2004])
  • Pension Fund Association ($117 billion [2004])

Canada

The most important Canadian institutional investors are:

United Kingdom

In the UK, institutional investors may play a major role in economic affairs, and are highly concentrated in the City of London's square mile. Their wealth accounts for around two thirds of the equity in public listed companies. For any given company, the largest 25 investors would have be able to muster over half of the votes.[11]

The major investor associations are:

The IMA, ABI, NAPF, and AITC, plus the British Merchant Banking and Securities House Association are also represented by the Institutional Shareholder Committee.

See also

Business and economics portal

Notes

References

Articles
  • AA Berle, "Property, Production and Revolution" (1965) 65 Columbia Law Review 1
  • LW Beeferman, "Pension Fund Investment in Infrastructure: A Resource Paper", Capital Matter (Occasional Paper Series), No.3 December 2008
  • BS Black and JC Coffee, "Hail Britannia?: Institutional Investor Behavior under Limited Regulation" (1994) 92(7) Michigan Law Review 1997
  • G Clark and A Clark, "Common Rights to Land in England, 1475–1839" (2001) 61(4) The Journal of Economic History 1009
  • JC Coffee, "Liquidity versus Control: The Institutional Investor as Corporate Monitor" (1991) 91 Columbia Law Review 1277–1368
  • PL Davies, "Institutional investors in the United Kingdom" in T Baums et al., Institutional Investors and Corporate Governance (Walter de Gruyter 1994) ch 9
  • MN Firzli & V Bazi, "Infrastructure Investments in an Age of Austerity : The Pension and Sovereign Funds Perspective", USAK/JTW 30 July 2011 and Revue Analyse Financière, Q4 2011
  • KU Schmolke, "Institutional Investors' Mandatory Voting Disclosure: The Proposal of the European Commission against the Background of the US Experience" (2006) EBOLR 767
Books
  • A Chandler, The Visible Hand (1977)
  • PL Davis et al., Institutional Investors (MIT Press 2001)
  • MC Jensen (ed), Studies in the Theory of Capital Markets (F. Praeger 1972)
  • GP Stapledon, Institutional Shareholders and Corporate Governance (Oxford 1996)

External links

  • Sovereign Wealth Fund Institute - Source for Sovereign Wealth Funds
  • Institutional Investor Magazine

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