Importance of Institutional Investors for Financial Markets - Literature review Example

Importance of al investors for financial markets Importance of al investors for financial markets Introduction In the past few decades there is an accumulative rise of institutional investment, especially in the developed financial markets like UK and United States respectively. The growth of institutional investment indicates its collective role and importance in both the stabilized and emerging stock markets. With the expansion of financial markets with respect to the GDPs of the growing stock exchanges, there has been a continuous joining up of private and institutional investors (Davis, 2001). It is all because there is a major role the investors have to play in the statuses of financial markets. This study is going to analyze the significance of institutional investments with respect to the financial markets (Davis, 2001). The study will cover and evaluate all major areas of institutional investments, in order to come to a better and deliberate understanding on the subject (Davis, 2001). Background According to modern financial studies, institutional investment is contributing a big share in the financial market system. There is continuous amount of flow in institutional investment, which has raised the pond of finance and investment (Davis, 2001). The positive influence is because of persistent rise of private investment firms (supply), and also because of individual beneficiaries who assist people on pensions and financial policies (demand). With supply on one side and demand on the other, institutional investment is on the centre to maintain the balance of the financial system. This is how both supply and demand constraints are fed with private investment funds, which are on monthly, quarterly and year based policies (Davis, 2001). With the rise in demand of institutional investment, there is an organized, improvised and diversified chain of institutional investors who balance the demand at the right time of assistance. There is a composed system of institutional investors which includes diversity, vigilance, and corporate level assistance to manage beneficiaries and owners’ private shares and investments (Davis, 2001). Explanation Institutional investment is an investment related to organized institutions. Such institutions are care takers of others’ equities and private holding investments. The role of institutions is deliberate as they set a system of organizing, developing and managing respective funds. Such funds are prepared to get reinvested which is to attain the benefit out from investments. There are different types of institutions that manage and organize investments (Davis, 2001). Such include pension institutions, insurance companies, savings institutions and foundations respectively. All institutions are important with respect to the area of finance they manage and deal with. It is their specialized skill which recovers the benefit out from the investment, as they are more aware of the market trends and regulations than the ordinary man “a common investor” (Davis, 2001). Institutional investments like pension funds have a great role in developing economics. Like pension funds mount up the amount and number of investments attained by company employers in respect of their employees. The amount gets doubled and tripled after some time, depending on the rates on which it has been fixed, and adds a consistent share in the financial stock market until the policy gets expired. This is how regulations, policies and instrumentations of pension funds (institutional investment) retrieve the best outcome (liquid assets) for both investors and managers of the fund. The importance of pension institution funds vary with respect to the changing norms of countries’ markets. According to International Financial Services London (IFSL) 2004, UK projects an amount of $1,400 billion in the pension funds prospect, adding a major share in the UK’s financial stock market (BGL, 2010). The contribution of pension funds is there for Germany and France financial markets, where a forecast indicates that pension funds will rise tremendously in the coming years of time. The sound technical assistance of pension funds benefits both the employers (people who buy pension policy) and pension takers (old age people who expect pension in the retirement). The fund raised by a pension policy is then further pooled by financial institutions (Meng & Pfau, 2010). The amount is added to stock market index, which further gets invested in banks, private loan companies, insurance companies, shares, bonds and state agent services. This is how when the cycle of the pension fund completes, it benefits all areas including institutions, private investors, pension holders, and the economics of the country in which the policy has been administered (Meng & Pfau, 2010). Hedge funds are other major form of institutional investments. They are institutional because such funds hold the ability to discharge risk in a composite manner. The regulation of hedge funds adds managers, investors and sleeping partners in the policy (Davis, 2001). In respect of the policy, managers come under the major liability and risk to control, while private partners like investors are restricted to the limited amount of risk accompanied by their sums of investment. This is how hedge funds are most replicated form of institutional investments that generalize risk to all parties who are part of the investment (Davis, 2001). This is how a balance is created by hedge funds in the financial stock market, where managers are specialists to bear risks and investors are active to add up the funds. Hedge funds place a great opportunity to small investors, as it is one method to encourage small private investors and raise big capitals. One drop of a private invested share makes an ocean of a highly organized hedge fund, which further gives the opportunity to private equity firms to empower the stock market (Davis, 2001). According to Jeremy Seigel (Professor of Finance at University of Pennsylvania), hedge funds are most viable form of institutional investments. Such investments are quite effective in strengthening the investment strategies, especially when the market is receiving high price deflections. In price deflection situation, hedge funds are quite comfortable to control price variations (HFF, 2009). Likewise in financial markets, hedge funds increase short selling of the stocks, which eventually controls the price as market quickly finds accurate prices on the stocks. According to Sebastian Mallaby (A member of Council of Foreign Relations) hedge funds are risk deviators, as they deviate risk from investor’s side, from banks and even from the financial market, as all the risk is shifted back to the integrated fund pool. Hence by inclusion of hedge funds, there is a great promotion of economic activity, which is sufficient to back the stock market in deep stress situation (HFF, 2009). Institutional investors utilize hedge funds in order to organize private equities and investments. Hedge funds provide a great room to spend on different markets which later on helps institutional investors to strategize and deliver (Davis, 2001). There is no such fixation one could find in hedge funds policy, which helps the investors to outplay in a dynamical stock environment. In hedge funds investors get a chance to invest globally and on the domestic level, in order to retrieve the benefits for investors and also for the market in a major extent (Davis, 2001). All of this leads to investment diversity, which later on brings the market to stand in the global competition (HFF, 2009). The US market rise of $32 trillion 2008 indicates that investment diversity upraises the status of the financial market. Likewise with investment diversity, the US stock went across the board (Bahrain, China, India, and Dubai) to lead out the competition. All of this shows that hedge funds (institutional investments) encourages diversified investment, which later on give a boost to domestic financial market (HFF, 2009). According to modern economist’s perception, institutional investments are centralizers of investment, as they involve institutions that understand the changing market trends and the ability to invest at the right time (Davis, 2001). Most precisely institutional investors are form of mediators. They are intermediaries that maintain the relationship between borrowers and lenders. This is to prolong the relationship in terms of the benefit for the investment being made. As per the scale of economics, institutional investors are policy executors; they execute policies which are in high favor of investment and the market (Davis, 2001). One major role of institutions is that they keep an inside view of corporate that is being invested, which is to satisfy the investor involved and the receiver which is indirectly present. This is how institutions manage the cycle of investment, inducing benefit to market and to market components (investors and share holders) (Davis, 2001). There are further control strategies like mutual funds which institutions apply in stressed based market situation. Like in India 1991, when there was high inflation rate, high unemployment and high rates of interest to settle the low forex reserves, institutional strategists like IMF came up to control the situation. The trend followed on in India where the coming up investors tried the same customs (mutual funds) as proposed by IMF to stabilize the Indian financial market. According to the Global Asset Management (2006) report, India will hold a financial reserve of $1 trillion in the prospect year 2015. This is all because of the pace of mutual funds industry which is rising with an annual growth rate of 16.68 percent (Rao & Mishra, 2007). This indicates that how aggressively new funding schemes are being introduced like mutual funds contributing a major portion of financial market in India. Hence with the rise of the mutual funds industry, organizations like AMFI have indicated a rise of GDP in the coming years of time. One reason of growing mutual funds industry is that Indian private institutions are on high value of trust from the private investors. Investors directly rely on institutions giving major investments on the year wise programs and policies. This has leaded the growth of Indian stock market and so as the expansion of private investing firms which are motivated to expand the status of financial stock market (Rao & Mishra, 2007). Apart from developing regions, mutual funds are in a great role to support financial markets of UK and United States. According to World Bank’s report (1997), mutual funds are one major form of financial instruments that covers the risk of financial markets, like in 1980s mutual funds came out as close-end funds to stabilize the illiquid market sections of UK. A similar perception is in there in United States, where different forms of mutual funds (hybrid funds, asset allocation funds, target risks funds) evolve a 6% share in the US financial stock market (Rao & Mishra, 2007). This is to extend the liquidity of the market and to deduce the volatility of market in respect of time (Rao & Mishra, 2007). In modern studies mutual funds are considered as most screening form of institutional investments. Such funds hold the objective to favor partnerships, but there are other concerns like managing the corporate structure that are part of a mutual fund policy (Madura, 2009, pp.587). When mutual funds invest large amounts in stocks, they get a natural authority to screen the big size firms (corporations). Fidelity (a foundation) is one common example that owns around 700 corporations via mutual funds administration. By such intrinsic and legislative know-how of the firms, Fidelity is able to advice better to investors as the foundation is much aware of market trends and organizations’ internal setups. This is the room Fidelity tends to exercise via mutual fund policy regulation and benefit the financial stock market in the end (Madura, 2009, pp.587). Conclusion Since the past few decades there is a consistent rise of institutional investment seen in the emerging financial markets. The rise itself indicates that how much important institutional investments are for both emerging and developed economics of the world. There are different types of institutional investments like hedge funds, pension funds and mutual funds, which hold distinctive importance with respect to their applications (Davis, 2001). Like hedge funds play a decisive role in distributing the risk of the investment, as the major part of risk is transferred to managers (active partners) while the rest is on the private investors (sleeping partners) to balance the risk and benefits. Similarly there are other types of institutional investments like mutual funds, which are essentially important in a down-turning market situation. Mutual funds with their respective classifications like hybrid funds or asset allocation funds hold distinctive importance in a stress holding market (Rao & Mishra, 2007). In India mutual funds played a decisive role in addressing the 1991 country recession, where strategists from the world (IMF) designed mutual funds to revive the economic progress in the country (Rao & Mishra, 2007). Institutional investments like pension funds have a subsequent role in developing world economics. The pension policies are sufficient to mount up the amount being invested which is further raised to give benefit to the partners associated. With the adaption of the policy, the amount gets doubled and after some time it is enough to support the status of the financial stock market (HFF, 2009). This is how regulations, policies and instrumentations of pension funds (institutional investment) retrieve the best outcome (liquid assets) for both investors and managers of the fund (Rao & Mishra, 2007). List of References BGL, 2010. Situating Nigeria in the Global Pension Industry. Research Report. Lagos: BGL. Davis, E., 2001. Institutional investors, financial market efficiency, and financial stability. Case Study. London : Brunel University. HFF, 2009. Hedge Funds Benefits. [Online] Viewed at: [Accessed 10 December 2012]. Madura, J., 2009. Financial Markets and Institutions. Mason: Cengage Learning. Meng, C. & Pfau, W., 2010. The Role of Pension Funds in Capital Market. Research Report. Tokyo: GRIPS. Rao, P. & Mishra, V., 2007. Mutual Fund: A Resource Mobilizer in Financial Market. Vidyasagar University Journal of Commerce, 12, pp.109-15. Read More