Institutional investors are what “whales” are to the gambling world. Except they are not people. They are, well, institutions, i.e., pension funds, mutual funds, insurance companies, banks, trusts, endowment funds and others.
As to why institutional investors are important, for one thing they account for 50% of the trades on the New York Stock Exchange. They buy and sell huge blocks of stock and have tremendous influence on the stock market.
Institutional investors represent the smart money in the market. How institutional investors behave about a certain stock is often seen to be sending a strong signal about a company’s health and future.
One important caveat: If you are a fundamental investor you need to know that the connection between a company’s fundamentals and interest shown by institutional investors isn’t always driven by fundamentals.
When To Get In
After an institutional investor establishes a position in a stock, their next move is usually to try to drive up the price of the stock. They do this by driving up interest in the stock. It can be as simple as going on financial television networks and touting the company or the stock. It’s advertising 101.
The best time to get in and take advantage of what has a good chance of being a worthwhile stock is at or near the beginning of the buying process by the institutional investor. It’s important to track and follow institutional investor holdings. This is easy to do with FinanceBoards’ “Institutions Widget. For more see: FINANCEBOARDS WIDGET SPOTLIGHT #17: THE INSTITUTIONS WIDGET
There Is A Downside
Institutional Investors should not be considered the “be-all” and “end-all” of stock picking. Far from it. For one thing, in the instance of a mutual fund, a given portfolio manager might be evaluated on his performance during a quarter. This could cause the manager, especially if he is having a bad quarter, to dump underperforming positions and buy stocks with momentum.
For you as an investor, following this pattern could lead to excess trading costs, poor tax situations and even unnecessary losses due to the fact the fund manager is selling some stocks at the wrong time.
Related: STANDARD & POOR’S 500 INDEX
Compared To You
As a retail investor, you pay brokerage firm fees, marketing and distribution costs every time you trade. Institutional investors send their trades to exchanges independently or through intermediaries. As a result, they negotiate a set fee for trades and avoid marketing and distribution costs.
While institutional investors invest in bonds, options, futures contracts and stocks – just like you, sometimes they invest in markets primarily for them. Examples would include swaps and forward markets. While you buy and sell stocks in lots of 100, institutional investors deal in blocks of 10,000 shares. They avoid buying smaller companies where they could acquire a high percentage of ownership due to restrictions placed on them by securities laws.