Importance of Institutional Investors Finance Essay

Assess the importance of institutional investors for financial markets. 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. Types of typical investors include banks, insurance companies, retirement or pension funds, hedge funds, sovereign wealth funds, endowment fund, investment advisors and mutual funds.

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A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural goods. These financial markets are of two types; capital markets and money markets.

Financial markets facilitate the following; the raising of capital (in the capital markets), the transfer of risk (in the derivatives markets), price discovery, global transactions with integration of financial markets, the transfer of liquidity (in the money markets) and international trade (in the currency markets). Generally these markets are used to match those who want capital to those who have it.

There are plenty of paramount reasons of having institutional investors in financial markets, the importance are as elaborated below;

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. Also they influence in the management of corporations because they will be entitled to exercise the voting rights in a company.

According to Cvetanovic (2006); Institutional investors have a high preference for liquid assets. They usually have more power than small investors to press for the lowest possible transaction costs thereby boosting liquidity in terms of share turnover in the market. For instance, in 2009, institutional investors managed financial assets in excess of USD 53 trillion, including some USD 22 trillion in equities (OECD 2011). This, in turn, can reduce the cost of capital which should make it easier for liquidity-constrained firms to obtain fresh capital infusion.

Furthermore, institutional investors are small but important players in corporate governance. As large and diversified investors with strong preference orientation they have the potential and the incentive to press for value-maximizing firm governance. So, institutional investors are in the process of financial development in each country and also provide strong contribution to development of financial sector functions (Cvetanovic 2006).

Large block acquisitions and disposals by institutional investors may cause major swings in share prices. There are passive investors who just replicate what large investors do in the financial market. Since institutional investors hold large sums of funds, they normally purchase companies shares and at times dispose them. In an event a huge amount of shares are bought by one of these institutional investors such as the pension funds and the insurance companies would result to a major share price rise of such shares. And once the institutional investors dispose the shares of any company they hold, would result in a fall in price of such company shares as investors would predict something wrong with the company. The behavior of institutional investors may also give rise to fads and fashions with potentially unhealthy effects on merger activity. They may cause a disproportionate rise in the share prices of the firms in which they invest. This gives the firms in which they invest a greater opportunity to leverage their financial position in an acquisition (Dhaliwal 1992).

Financing young or small firms and businesses: Institutional investors do provide finance or private equity to small businesses by buying shares of such businesses. Institutional investors may own private equity firms, which are firms that buy the shares of new or small businesses even though the shares are not tradable on a stock exchange. Private equity firms become co-owners of the companies in which they invest and take an active managerial role in the companies. The expectation may be that the shares will eventually be sold to another private equity firm, to another firm that makes a takeover bid, or through a stock exchange when the shares are accepted for a stock exchange listing (Redhead 2008). . According to Valdez (2007) Cited in Redhead (2008:245) in 2006 the European Private equity Capital Association provides the data of the European Private Equity in 2005. Pension funds provided 24.8% of the finance, ssbanks 17.6% funds of the funds contributed 13.1%, insurance companies provide 11.1% and individual investor 6%.

In light of the assets held by institutional investors relatively to the GDP, It’s clear that institutional investor as group manage very important amounts of capital ranging from capital stock equal to 81% of GDP in Germany to 191% in the U.S.A and the U.K 2001. Anglo Saxon Institutional investor hold a significance position through repartition as in Belgium, France, Italy where the active population generates the pension of the retired. These countries have developed a capitalization system where by individual save for their own pension. The Global growth rate of institutional assets/GDP ratio is large and range between 134% in France and 356% in Italy. Also the fraction of total assets invested in stock market is significantly larger in U.K and U.S.A, example in U.K invest around 65% of their resources in the stock market and in U.S.A invested in the stock market (Huyghebaert and Hulle, 2004).

In view of the combination of rising weight in the economy and increasing appetite for shares, institutional investors have become an increasingly important investor group in the stock market, especially in Continental Europe. As these investors have demands, behavior and interests different from small individual shareholders, this phenomenon is likely to affect publicly quoted firms and stock markets in general (Huyghebaert and Hulle, 2004).

The buy and hold policies of insurance companies and pension funds may eventually create highly volatile equity markets.

Institutional investors and the liquidity of the financial markets: This deal with the ease of converting assets held by the institutional investors into cash. For one of the important properties of a stock market is that, as investors assemble information and act upon it, the information becomes reflected into the stock price. Hence the less trading, the less opportunity for information to be (timely) incorporated into the price, and the more uncertainty about the stock’s underlying value. Furthermore, as liquidity decreases, fewer investors are interested in the stock, so that overall information collection tends to decline. Finally, since it is more difficult to find interested buyers, an illiquid stock is more costly to turn into cash. As a consequence, the seller of an illiquid stock will have to accept a discount on the selling price. Consequently, as uncertainty about the underlying value increases, as less investors are interested to buy it and as trading becomes more costly, the share price decreases (Huyghebaert and V. Hulle, 2004).

The Institutional investor especially mutual funds are liquid since it is easy to acquire, and dispose off, portfolios of shares by means of buying and selling mutual funds. If investors need to invest in mutual fund, they will buy share or stock then they will sell when markets are rising and buy when markets start falling (Huyghebaert and V.Hulle, 2004).

The necessary voting strength to influence company directors on which investments to make: This appears to be the case when their investment bank does (or prospectively does) business with the company whose shares are being analyzed. There is a conflict of interest wherein pressure from within their investment bank influences the recommendations of analysts. Good recommendations are favored in order to please corporate clients (or prospective clients). If an analyst makes a negative recommendation on the stock of a company, that company could transfer its business to another investment bank (Redhead 2008).

A A 

A Institutional InvestorsA Play a Role in Reducing Information Asymmetries: In the financial market, information is of paramount importance.A Institutional investorsA with their large capital usually seek and demand the right information from the firms selling shares of stocks. Firms on the other hand, and inA reactionA to the demand of theA institutional investorsA that 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 (Balling, Holm and Poulsen, n.d.). 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.

A A A A A A A A A A A 

Institutional InvestorsA Influence Corporate Governance to Increase Profitability:A Institutional investors, with their enormous wealth and ownership of the majority of stocks of a firm can influence and wieldA power overA corporate governance. There are passiveA institutional investorsA who do not interfere with the operation of the firm. This was the case before the 1990s. But there are alsoA institutional investorsA who seek to influence control in the management of the company to improve profitability (Bofah, 2010). The latter is a phenomenon called shareholder activism. Activist institutional shareholders stirredA financial marketsA of developing nations in the 1990s. In 1992 chief executive officers of very large firms such as IBM, GENERAL MOTORS,AMERICAN EXPRESS WESTINGHOUSE And COMPAQ COMPUTERS HYPERLINK "https://ivythesis.typepad.com/term_paper_topics/2009/10/the-american-scholar-.html"were fired under the pressure ofA institutional investors. (Latest-ScienceA articles, n.d.)

Conclusively, institutional investors are important for both the financial markets and the country as well. They hold large amounts of funds which are invested in various sectors and so play a huge part in the daily activities of the financial markets through buying and selling of numerous stocks they hold of such companies.

In Tanzania, institutional investors such as banks, insurance companies and largely the pension funds, engage much in the financial markets and aid the growth of small firms in the country and boost the economy of the country.

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