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Institutional investment - Essay Example

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The Role of Institutional Investors in Financial Markets In many financial markets, particularly in developed economies (with the exception of countries like Japan), institutional investors have grown by leaps and bounds. For example, in the United Kingdom, 75% of the market valuation of all stock is held through institutional investment…
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Download file to see previous pages This development has shifted the attention to the role and importance of institutional investors to financial markets. What this means is that these entities came to dominate and dictate the trajectory and the pattern of investment choices, affecting the dynamics of financial markets in the process. This paper will explore this theme. This objective will be undertaken in the context of financial markets with high institutional investors. Institutional Investors: A Background There is no standard definition or precise concept explaining the dynamics of institutional investors. But Lumpkin (2000) offered a general view, which will effectively serve the purpose of this paper. He explained that institutional investors are those financial institutions that invest savings of individuals and non-financial companies in the financial market (pp.195). The breadth and diversity of this definition can be tempered by a key requirement: That, money is being managed by institutions as distinguished by those administered by retail investors. Based on this definition seven principal categories of institutional investors exist: private pension funds; state and local retirement funds; mutual funds; life insurance companies; property and casualty insurance companies; non-pension fund money managed by banks; and foundation and endowment funds (Baums and Buxbaum, 1994, pp.667). This classification highlights a diversity which means that institutional investors are driven and influenced by different factors. There are however commonalities. For example the sector operates on the basis of well-defined risk-return criteria and employs sophisticated investment strategies and methods (Blommestein and Funke, 1998, pp.69). Furthermore, the OECD identified the common factors that drive the growth of this sector: There is a rising demand for retirement “products” such as mutual funds and guaranteed-equity plans, among others, due to the increase of ageing population in developed economies; The technological development especially in communications, computing and information fields lead to the enhanced capabilities of institutional investors to provide intermediation and services that entail minimal risks, with all these transpiring at very high speed but at a cheaper cost; There is the deregulation of the banking and securities industries since 1980s, which intensified competition among financial institutions, further encouraged by easing of restrictions on cross-border capital flows (Lumpkin, pp.198). All in all, the theoretical underpinning for institutional investment is intermediation. Wealth is not directly funneled to the market. Instead, money is delegated by investors to managers who will manage it in turn. This is fundamentally different from investments by individual agents or by the manner by which corporate entities own and manage their stocks. The business model works because the operational landscape is conducive and the outlook is very favorable as demonstrated by current statistics, trends as well as projections by experts and agencies like the OECD. The Role of Institutional Investment There is the claim that institutional investment is critical in the modernization of financial markets. To put it another way, its emergence has supposedly brought about reforms that led to the efficiency in financial market. This argument appears to be valid because institutional inv ...Download file to see next pagesRead More
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