Why institutional investors are important in the world of business

They must tackle other structural impediments too. One is increasing portfolio diversification, which makes it difficult to allocate the necessary time and resources to monitor and engage with companies.

Another is a growing distance between the professionals who manage the money and the asset owners, representing hundreds of millions of people who depend on the former for their long-term savings and financial security when they retire.

Stewardship is not about asserting control over boards and management. The recently issued UK Stewardship Code, 1 1. FRC is an independent regulator responsible for promoting confidence in corporate reporting and governance in the United Kingdom.

Governance issues such as board effectiveness, executive remuneration, and succession planning should be high on the agenda, alongside matters such as strategy and risk. Just as important, investors should not pressure a company to deliver short-term returns. Moreover, they should take the time to understand the key drivers of its long-term performance rather than simply seeking granular data points to plug into their models. Consider debt levels: in the run-up to the financial crisis, some investors looking for better returns insisted that companies take on high levels of debt, which did not serve them well when the crisis struck and in the deleveraging phase that continues today.

Many corporations might benefit from more attentive stewardship by large shareholders. Fortunately, some farsighted institutional investors have overcome the structural barriers, in the investment industry, that stand in the way of taking more active ownership and a long-term perspective. These investors do things differently, and evidence suggests the following practices can produce better results.

This practice can help ensure that managers are not rewarded undeservingly in a bull market or punished inequitably in a market downturn. But it also tends to encourage a focus on short-term results, which in turn discourages an active interest in how companies are governed and managed. Asset owners can encourage long-term thinking and active ownership by lengthening the period for performance reviews and reducing the emphasis on relative returns. This approach is particularly important when external investment managers are involved.

To measure performance quantitatively, it may be sensible to supplement comparisons to market indexes with other metrics, such as internal rates of return for exited investments. Some asset owners have embraced this approach. One US public-pension fund, having committed itself to a three-year investment, refused to meet the asset manager during the first year to discuss results, believing that a full review of performance should occur only after the second year.

These intermediaries form layers between the ultimate beneficiaries and the companies they invest in. Leo E. Strine Jr. Where possible, pension funds and other long-term asset owners should strengthen their internal capabilities. In the past decade, the nine largest Canadian public-sector pension funds averaged annual returns of 5.

In-house investment managers, who breathe the culture of the pension funds they serve every day, are likely to add more value than outside agents, who may not feel the same sense of long-term mission as a result of sheer physical distance and the need to serve a broad set of investor clients. In countries with many small pension schemes, such as the United Kingdom, consolidation would be one way to build scale and thereby strengthen the ability of pension funds to recruit investment talent.

Many investment professionals view portfolio diversification as one of the surest ways to achieve good market returns and reduce portfolio volatility. However, the practice of constructing stock portfolios around the market benchmarks that fund managers are measured against often takes diversification too far.

Such diversification makes it very difficult to pursue resource-intensive engagements with boards of directors, which can yield more meaningful insights than scanning annual reports. Two large Dutch pension funds are contemplating shrinking their equity portfolios by 90 percent, to to holdings, to improve their capacity to be active owners.

Institutional investors that concentrate their holdings have an added incentive to monitor investee companies well, since the performance of each holding has more impact on the returns for both the firm and individual fund managers. A slimmer portfolio will also likely instill stronger investment discipline. Passive funds, which seek to replicate a broad market index, face an even tougher stewardship challenge because of their low-cost business model.

These funds have enjoyed a resurgence of interest among retail and institutional investors in many markets because of their low fees and outperformance of actively managed funds. Since they are betting on long-term gains in the broad equity market and have very little room to shift their holdings, passive funds should have good reason to engage actively with companies in their index.

Yet a recent study of UK investment firms 7 7. For passive funds, better stewardship may need to take more modest forms than the resource-intensive approach possible in actively managed funds with a relatively small number of holdings. These advantages may have eroded over the years as information has become more transparent and accessible, and regulation has limited disclosure by public companies.

Institutional investors include public and private pension funds, insurance companies, savings institutions, closed- and open-end investment companies , endowments and foundations. Institutional investors invest these assets in a variety of classes. However, these figures drastically vary from institution to institution.

Pension funds receive payments from individuals and sponsors, either public or private, and promise to pay a retirement benefit in the future to the beneficiaries of the fund.

This law established the accountability of the fiduciaries of pension funds and set minimum standards on disclosure, funding, vesting, and other important components of these funds. Investment companies are the second largest institutional investment class and provide professional services to banks and individuals looking to invest their funds. Most investment companies are either closed- or open-end mutual funds, with open-end funds continually issuing new shares as it receives funds from investors.

Closed-end funds issue a fixed number of shares and typically trade on an exchange. Open-end funds have the majority of assets within this group, and have experienced rapid growth over the last few decades as investing in the equity market became more popular. However, with the rapid growth of ETFs, many investors are now turning away from mutual funds. The Massachusetts Investors Trust came into existence in the s and is generally recognized as the first open-end mutual fund to operate in the United States.

Investment companies are regulated primarily under the Investment Company Act of , and also come under other securities laws in force in the United States. Insurance companies are also part of the institutional investment community and controlled almost the same amount of funds as investment firms.

These organizations, which include property and casualty insurers and life insurance companies, take in premiums to protect policyholders from various types of risk. The premiums are then invested by the insurance companies to provide a source of future claims and a profit. Most often life insurance companies invest in portfolios of bonds and other lower risk fixed-income securities. Property casualty insurers tend to have a heavier allocation to equities.

Savings banks are highly regulated entities and must comply with rules that protect depositors as well comply with federal reserve rules about fractional reserve banking. As a result, these institutional investors put the vast majority of their assets into low-risk investments such as Treasuries or money market funds.

Depositors of most U. Foundations are the smallest institutional investors, as they are typically funded for pure altruistic purposes. These organizations are typically created by wealthy families or companies and are dedicated to a specific public purpose. Institutional investors remain an important part of the investment world despite a flat share of all financial assets over the last decade and still have a considerable impact on all markets and asset classes.

Securities and Exchange Commission. The Conference Board. Accessed June 7, Department of Labor. MFS Investment Management. Federal Deposit Insurance Commission. Investing Essentials. Mutual Fund Essentials. Mutual Funds. Hedge Funds Investing. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content.

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