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Investment - Types and Characteristics of Investors
Introduction to Investor Types
Investors are not a homogeneous group; both individual and institutional investors have diverse features. Clients differ in terms of their financial resources, objectives, personalities, financial expertise, and so on. These variances affect their financial demands, what services they require, and what assets are appropriate for them. Consider the following example:
Elderly customers with significant resources may be highly concerned with estate planning.
Elderly consumers with little resources may be more anxious about outliving their assets.
Thus, a gap in investment returns may have major ramifications for people concerned about outliving their assets but have less impact on those with significant resources.
Investors can own securities, such as shares and bonds, directly, or they can invest in professionally managed funds to acquire market exposure. Investors may choose securities or funds themselves or contact an investment professional to aid in the decision. Investment experts attempt to provide appropriate investment services to fulfill clients’ demands.
The most basic distinction among investors is that between individual and institutional investors.
INDIVIDUAL INVESTORS
Individual investors trade (buy or sell) securities or permit others to trade stocks for their personal accounts.
INSTITUTIONAL INVESTORS
Institutional investors are organisations that hold and manage portfolios of assets for themselves or others.
The traits that distinguish individual investors are frequently distinct from those that define institutional investors.
Individual Investors
Individual investors are often differentiated based on their resources. The word ‘retail investor’ can be used to refer to all individual investors, although it is typical to use the term to refer to individual investors with little resources to invest. Many investing businesses create a distinction between their regular clients, more affluent clients with higher amounts to invest, and high- and ultra-high-net-worth investors, who have the biggest amounts of investable assets.
The services supplied by investment businesses and the investments available will often vary by the amount of money the client has to invest. Some specialist funds may need minimum quantities of investment (e.g., USD1 million), and some portfolio management services may have minimum costs, rendering them uneconomical for lesser account sizes.
An investment firm that focuses on retail investors has to satisfy the needs of a large number of relatively modest accounts. Doing so often implies consolidating the retail investors’ assets into a smaller number of funds and establishing automated systems for the administration of client fund holdings.
An investment firm or division within an investment firm specializing on high-net-worth investors may have fewer clients, but greater average account balances, than one that concentrates on regular investors. Investor assets may still be placed in funds, however some high-net-worth investors will prefer their own segregated accounts (known as separately managed accounts). Wealthy clients may have higher expectations of client service than retail consumers, and usually the services that are delivered to them are more individualized.
Individual investors vary in their level of investment knowledge and competence. Some individual investors have very limited investment knowledge and competence, and others are more knowledgeable, maybe as a result of their schooling or work experience.
Because individual investors are typically viewed of as less knowledgeable and less experienced than institutional investors, regulators in many countries try to safeguard them by setting restrictions on the assets that can be sold to them.
For example, as of 2022 in the United States, the Securities and Exchange Commission (SEC) restricts investing in some alternative investments to accredited individuals. An individual qualifies as an accredited investor if they have earned income of USD200,000 or more in each of the prior two years and has a reasonable expectation to earn at least USD200,000 in the current year, or has (alone or together with a spouse) a net worth (excluding his or her primary residence) greater than USD1 million.
This restriction is based on the assumption that wealthier investors are anticipated to have a higher level of investing expertise — or access to professional investment counsel — and possess a greater ability to forgo investment liquidity.
Additional variables of the personal situations of individual investors, such as age and family obligations, may also differ and affect their investing demands and decision making. The planned holding term (time or investment horizon) for investments, risk tolerance, and other conditions also affect investors’ needs.
Retail Investors
The investing sector delivers primarily standardised services to retail investors because they make the least money per investor for investment firms. Many retail investing services are supplied online or by customer service personnel working at call centres.
High-Net-Worth Investors
Wealthier investors often receive more personal attention from financial experts. Their investment problems sometimes involve tax and estate planning complications that demand greater resources and professional knowledge. They either pay directly for these services on a fee-for-service basis or indirectly through commissions and other transaction charges.
Ultra-High-Net-Worth Investors and Family Offices
Very affluent individuals generally employ professionals who help them manage their money, future estates, and legal concerns. These specialists generally operate in a family office, which is a private corporation that administers the financial affairs of one or more members of a family or of numerous families.
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Many family offices serve the heirs of huge family fortunes that have been acquired over generations. In addition to investing services, family offices may provide personal services to the family members, such as bookkeeping, tax planning, managing household personnel, making travel arrangements, and coordinating social events.
Wealthy families generally have huge real estate holdings and large financial portfolios. The investment professionals who work in family offices often handle these investments using the same strategies and processes that institutional investors use. They pay especially close attention to personal and estate tax issues that may considerably affect the family’s wealth and their capacity to transfer money on to future generations or charity institutions.
Institutional Investors
Institutional investors are organisations that hold and manage portfolios of assets for themselves or others. There are numerous different sorts of institutional investors with differing investment criteria and limits. Institutional investors may invest to promote their mission, or they may invest for others to address the others’ needs. Institutional investors that invest to achieve their missions include the following:
Pension plans
Endowment funds and foundations
Trusts
Governments and sovereign wealth funds
Non-financial companies
Institutional investors that invest to provide financial services to their clients include investment companies, banks, and insurance companies. Some institutional investors handle their investments internally and employ investment specialists whose duty is to select the investments.
Other institutional investors outsource the investing of the portfolio to one or more external investment firms. The choice between internal and external management will frequently be influenced by the size of the institutional investor, with larger institutional investors better able to afford the resources required for internal management.
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Some institutional investors will choose a mixed model, managing some assets domestically in which they have competence and outsourcing more specialist investments — for example, alternative investments — to external managers. Those institutional investors that choose to outsource investment management still have significant decisions to make in terms of which managers to choose. They may use internal expertise to make manager selection decisions, or they may employ a consultant.
Pension Plans
Pension plans hold investment portfolios — that is, pension funds — for the benefit of future and existing retired members, who are called beneficiaries.
A firm or other body may set up a pension plan to provide benefits to its employees. The companies and governments that sponsor these plans are termed pension sponsors or plan sponsors. Money from employer and/or employee contributions is placed away to give income to plan members when they retire. The payments must be invested until the employee retires and receives the retirement benefits.
Pension plans differ by whether they are arranged as defined benefit or defined contribution schemes.
Defined Benefit Pension Plans
Defined benefit pension schemes promise a defined annual sum to their retired participants. The set amount normally fluctuates by member based on such factors as years of service and annual income while working.
Typically, employees do not have the right to collect benefits until they have worked for the company or government for a term set by the pension plan. An employee’s rights are vested (covered by law or contract) once they have worked for that duration.
Defined benefit pension funds, particularly those of government-sponsored schemes, are among the largest institutional investors. Pension funds may invest in equities securities, debt securities, and alternative assets because they often have relatively lengthy time horizons.
As employees retire, new employees are added to the plan. If new employees are not being added to the plan, the temporal horizon of the plan will diminish over time.
In a defined benefit pension plan, the sponsoring employer promises its members (or employees) a defined amount of benefit. For example, it is extremely typical for the company to promise a yearly pension that is a specified proportion of the employee’s final pre-retirement income.
The pension may be adjusted for inflation over time. The employer will pay contributions to the pension fund to honor the promise. Employees may also be asked to donate.
In a defined benefit plan, the employer bears the risk – in this example, that the investments made by the pension fund fail to perform as predicted. If the investments fail to perform as planned, the employer may be obliged to make further contributions to the fund.
But it is likely that pension sponsors will be unable to make the necessary contributions and that beneficiaries would not receive the benefits expected. Defined benefit plans are becoming less widespread around the globe and are being replaced by defined contribution plans.
Euro Pension Fund is the fund for a defined benefit pension plan located in Frankfurt, Germany. The plan sponsor remits money to the fund based on projections of pension benefit commitments compared with pension plan assets. Working members of the plan also pay a portion of their wages to the fund.
It has an asset management team that devises the fund’s strategy and implements it.
Defined Contribution Pension Plans
In a defined contribution pension plan, the pension sponsor normally contributes an agreed-on amount — the defined contribution — to an account set up for each employee.
Employees also often contribute to their own retirement plan accounts, primarily through employee payroll deductions.
The contributions are subsequently invested, generally in funds that the employee chooses from a list of approved funds inside the plan.
The plan gives enough options of funds to allow employees to establish a broadly diversified portfolio. The sponsor often limits the selections to a group of mutual funds sponsored by recognized investment managers. The pension plan sponsor should also guarantee that the costs levied on the funds are appropriate. At retirement, the money that has accumulated in the account is available to the employee.
In defined contribution plans, the member (or employee) takes the risk that the pension account’s investments fail to perform as predicted. This contrasts with defined benefit plans, in which the employer takes the risk.
In defined contribution plans, the employer has no commitment to make further payments if the investments perform poorly. If the retirement fund is less than projected, the employee may have to make do with less retirement income or, maybe, defer retirement.
Because saving enough and choosing the correct investments are very important, defined contribution plan sponsors are increasingly providing financial assistance to their beneficiaries or arranging for financial consultants to help guide members.
In the past, most pension plans were defined benefit pension plans. Because these plans promise defined benefits to their beneficiaries, they are expensive responsibilities for the sponsor (company) and many sponsors no longer offer them. This development explains why defined contribution pension plans are progressively replacing defined benefit plans in most countries.
Endowment Funds and Foundations
Endowment funds and foundations are also big institutional investors in many nations. Endowment funds are long-term funds of nonprofit institutions, such as universities, hospitals, and museums.
These institutions use their endowment monies to provide some services to their students, patients, and supporters. Foundations are grant-making institutions funded by gifts and by the investment income that they earn. Most foundations do not directly provide services. Instead, they fund entities that provide services in such areas as the arts or charities. Foundations often own endowment funds, which invest the foundation’s money.
Endowment funds and foundations often have a charity or philanthropic aim and accept endowments from contributors interested in supporting their activities. In many countries, gifts to these institutions are tax deductible for the donors.
That is, gifts diminish the income on which the donors have to pay taxes. Investment income and capital gains that these organisations get from investing these funds may also be tax-exempt.
Endowment funds are normally meant to remain in perpetuity and, as such, are viewed as very long-term investors. But they are also often mandated to spend annually on the benevolent or philanthropic objective for their existence, therefore money needs to be pulled from their funds.
Many endowment funds and foundations adopt spending criteria; for example, they may set expenditure goals of a percentage range of their assets. Often, their issue resides in combining long-term growth with shorter-term income or cash flow requirements.
Each endowment fund or foundation has its own special circumstances. Some are able to raise money on an ongoing basis, but others are limited from raising more money. Some endowment funds and foundations are mandated to spend a fixed part of the portfolio each year, whilst others have more flexibility to adjust spending.
These discrepancies have significance for how the institutional investor’s assets are invested. An endowment client that is barred from fundraising has to meet its financial needs from income or the sale of assets, whereas an endowment client that has no restriction on fundraising may also raise money to satisfy its financial needs.
Most institutions with endowment funds use professional investment managers to manage the funds. Some manage portions of their money domestically, in some cases through an investment management company that they control.
Governments and Sovereign Wealth Funds
Governments receive money from collecting taxes or selling bonds. When they do not have to spend this money immediately, they frequently invest it.
Some governments have accumulated significant surpluses from selling natural resources that they control or from financing the trade of goods and services. They create sovereign wealth funds to invest these surpluses for the benefit of present and future generations of their citizens.
Sovereign wealth funds often invest in long-term securities and assets. They also may purchase companies. Sovereign wealth funds either manage their investments in-house or engage investment managers to manage their money.
Non-Financial Companies
Analysts typically identify companies as either financial companies or non-financial companies.
Financial Companies
Financial companies include investment companies, banks and other lenders, and insurance organizations. These companies provide financial services to its clientele.
Non-Financial Companies
Non-financial enterprises produce items and non-financial services for their consumers.
These companies invest money that they do not presently require to run their businesses.
The money invested by non-financial companies may be invested short-term, mid-term, or long-term. The corporate treasurer usually controls the short-term investment assets. These assets often comprise cash that the company will need shortly to pay salaries and accounts payable and financial vehicles that are safe and liquid, like demand deposits (checking accounts), money market funds, and short-term debt securities issued by governments or other companies.
Long-term investments are normally managed under the leadership of the chief financial officer or the chief investment officer, if the company has one. firms often invest long term to finance future research, investments, and acquisitions of firms and goods. Companies may invest long term directly, or they may hire investment managers to invest on their behalf.
Some corporations invest directly in the shares and bonds of their suppliers and in the shares of possible merger partners to strengthen their relationships with them. Practitioners term these investments ‘strategic investments’. These types of investments are widespread in Asian countries, such as Japan and South Korea, and in European countries, such as France, Germany, and Italy.
Investment Companies
Investment businesses include mutual funds, hedge funds, and private equity funds. These firms operate exclusively to hold investments on behalf of its owners, partners, or unitholders (units refer to shares and bonds for equity and debt securities, respectively). These companies are called pooled investment vehicles because investors in these organizations pool their money for common management.
Investment companies are handled by experienced investment managers that work for investment management organizations. These management businesses often structure and market the investment companies that they manage and so function as the investment sponsors.
Mutual funds pool the assets of many investors into a single investment vehicle, which is professionally managed and benefits from economies of scale. There are thousands of mutual funds administered by investment management businesses.
Mutual funds are often classed by their investment(s). Investments eligible for inclusion may be strictly or broadly defined and based on categories of assets, geographic area, and so on.
For example, mutual funds may specify that they invest in Chinese equities identified as having growth potential, global equities, long-term investment-grade European corporate bonds, or commodities. The investment management business receives a fee for managing the fund. Although a mutual fund can be viewed as an institutional investor, the phrase ‘mutual fund’ also refers to the investment vehicle, shares of which an individual or institutional investor might hold in a portfolio.
Hedge funds and private equity funds can similarly be considered institutional investors that manage private investment pools and as investment vehicles. They are distinguished by their use of tactics outside the limits of most standard mutual funds (discussed in Course 2, Types and Functioning of Markets).
Insurance Companies
Insurance companies form another key group of institutional investor.
Insurance Companies collect premium from persons and companies they cover. Premium are required by insurance firms to offer insurance coverage for the policyholders.
Some of the premiums are deposited into a reserve fund form which insurance coverage can be paid. The premiums in the reverse funds are invested in broad portfolios of securities and assets that attempt to ensure that adequate money are always available to meet all claims.
Regulations typically impose rules to restrict the types of investments insurance firms can keep.
Insurance firms profit from the income they gain form float which is the amount money they have available to use after receiving premium and before paying claims.
There are two primary sorts of insurance businesses.
PROPERTY AND CASUALTY
Property and casualty insurance firms safeguard their insured from the financial loss caused by such catastrophes as accidents and theft.
Property and casualty insurers have short-term views and generally unpredictable payouts; therefore, they favor shorter-term assets that are more cautious and liquid.
LIFE
Life insurance firms give payments to the policyholder’s beneficiaries in the event the policyholder dies while the insurance coverage is in force.
Life insurers have longer-term time horizons and more predictable payouts and, thus, have more leeway to engage in riskier assets. They frequently invest their reserve funds, which often are extremely big, in stocks, commodities, real estate, and other real assets.
Some insurance firms give both forms of insurance.
nsurance businesses aim to match their investments to their responsibilities. For example, if they intend to make fixed annuity payments in the far future, they may invest in long-term fixed-income securities to match the interest rate risk of their assets to the interest rate risk of their liabilities.
This approach of matching investment assets to liabilities, called asset/liability matching, decreases the risk that the company would fail to fulfill its claims.
Most large insurance companies manage their investments in-house. They also may contract with investment managers to oversee specialty investments in industries, asset classes, or geographical regions where they lack expertise or access.
Investors — both individual and institutional — differ in their financial resources, circumstances, objectives, views, financial skills, and so on. These distinctions determine what services the client requires and what types of investments are appropriate for the client. Therefore, it is crucial to record information about the client and the client’s needs.
Introduction to Investor Types
Investors are not a homogeneous group; both individual and institutional investors have diverse features. Clients differ in terms of their financial resources, objectives, personalities, financial expertise, and so on. These variances affect their financial demands, what services they require, and what assets are appropriate for them. Consider the following example:
Elderly customers with significant resources may be highly concerned with estate planning.
Elderly consumers with little resources may be more anxious about outliving their assets.
Thus, a gap in investment returns may have major ramifications for people concerned about outliving their assets but have less impact on those with significant resources.
Investors can own securities, such as shares and bonds, directly, or they can invest in professionally managed funds to acquire market exposure. Investors may choose securities or funds themselves or contact an investment professional to aid in the decision. Investment experts attempt to provide appropriate investment services to fulfill clients’ demands.
The most basic distinction among investors is that between individual and institutional investors.
INDIVIDUAL INVESTORS
Individual investors trade (buy or sell) securities or permit others to trade stocks for their personal accounts.
INSTITUTIONAL INVESTORS
Institutional investors are organisations that hold and manage portfolios of assets for themselves or others.
The traits that distinguish individual investors are frequently distinct from those that define institutional investors.
Individual Investors
Individual investors are often differentiated based on their resources. The word ‘retail investor’ can be used to refer to all individual investors, although it is typical to use the term to refer to individual investors with little resources to invest. Many investing businesses create a distinction between their regular clients, more affluent clients with higher amounts to invest, and high- and ultra-high-net-worth investors, who have the biggest amounts of investable assets.
The services supplied by investment businesses and the investments available will often vary by the amount of money the client has to invest. Some specialist funds may need minimum quantities of investment (e.g., USD1 million), and some portfolio management services may have minimum costs, rendering them uneconomical for lesser account sizes.
An investment firm that focuses on retail investors has to satisfy the needs of a large number of relatively modest accounts. Doing so often implies consolidating the retail investors’ assets into a smaller number of funds and establishing automated systems for the administration of client fund holdings.
An investment firm or division within an investment firm specializing on high-net-worth investors may have fewer clients, but greater average account balances, than one that concentrates on regular investors. Investor assets may still be placed in funds, however some high-net-worth investors will prefer their own segregated accounts (known as separately managed accounts). Wealthy clients may have higher expectations of client service than retail consumers, and usually the services that are delivered to them are more individualized.
Individual investors vary in their level of investment knowledge and competence. Some individual investors have very limited investment knowledge and competence, and others are more knowledgeable, maybe as a result of their schooling or work experience.
Because individual investors are typically viewed of as less knowledgeable and less experienced than institutional investors, regulators in many countries try to safeguard them by setting restrictions on the assets that can be sold to them.
For example, as of 2022 in the United States, the Securities and Exchange Commission (SEC) restricts investing in some alternative investments to accredited individuals. An individual qualifies as an accredited investor if they have earned income of USD200,000 or more in each of the prior two years and has a reasonable expectation to earn at least USD200,000 in the current year, or has (alone or together with a spouse) a net worth (excluding his or her primary residence) greater than USD1 million.
This restriction is based on the assumption that wealthier investors are anticipated to have a higher level of investing expertise — or access to professional investment counsel — and possess a greater ability to forgo investment liquidity.
Additional variables of the personal situations of individual investors, such as age and family obligations, may also differ and affect their investing demands and decision making. The planned holding term (time or investment horizon) for investments, risk tolerance, and other conditions also affect investors’ needs.
Retail Investors
The investing sector delivers primarily standardised services to retail investors because they make the least money per investor for investment firms. Many retail investing services are supplied online or by customer service personnel working at call centres.
High-Net-Worth Investors
Wealthier investors often receive more personal attention from financial experts. Their investment problems sometimes involve tax and estate planning complications that demand greater resources and professional knowledge. They either pay directly for these services on a fee-for-service basis or indirectly through commissions and other transaction charges.
Ultra-High-Net-Worth Investors and Family Offices
Very affluent individuals generally employ professionals who help them manage their money, future estates, and legal concerns. These specialists generally operate in a family office, which is a private corporation that administers the financial affairs of one or more members of a family or of numerous families.
" "
Many family offices serve the heirs of huge family fortunes that have been acquired over generations. In addition to investing services, family offices may provide personal services to the family members, such as bookkeeping, tax planning, managing household personnel, making travel arrangements, and coordinating social events.
Wealthy families generally have huge real estate holdings and large financial portfolios. The investment professionals who work in family offices often handle these investments using the same strategies and processes that institutional investors use. They pay especially close attention to personal and estate tax issues that may considerably affect the family’s wealth and their capacity to transfer money on to future generations or charity institutions.
Institutional Investors
Institutional investors are organisations that hold and manage portfolios of assets for themselves or others. There are numerous different sorts of institutional investors with differing investment criteria and limits. Institutional investors may invest to promote their mission, or they may invest for others to address the others’ needs. Institutional investors that invest to achieve their missions include the following:
Pension plans
Endowment funds and foundations
Trusts
Governments and sovereign wealth funds
Non-financial companies
Institutional investors that invest to provide financial services to their clients include investment companies, banks, and insurance companies. Some institutional investors handle their investments internally and employ investment specialists whose duty is to select the investments.
Other institutional investors outsource the investing of the portfolio to one or more external investment firms. The choice between internal and external management will frequently be influenced by the size of the institutional investor, with larger institutional investors better able to afford the resources required for internal management.
" "
Some institutional investors will choose a mixed model, managing some assets domestically in which they have competence and outsourcing more specialist investments — for example, alternative investments — to external managers. Those institutional investors that choose to outsource investment management still have significant decisions to make in terms of which managers to choose. They may use internal expertise to make manager selection decisions, or they may employ a consultant.
Pension Plans
Pension plans hold investment portfolios — that is, pension funds — for the benefit of future and existing retired members, who are called beneficiaries.
A firm or other body may set up a pension plan to provide benefits to its employees. The companies and governments that sponsor these plans are termed pension sponsors or plan sponsors. Money from employer and/or employee contributions is placed away to give income to plan members when they retire. The payments must be invested until the employee retires and receives the retirement benefits.
Pension plans differ by whether they are arranged as defined benefit or defined contribution schemes.
Defined Benefit Pension Plans
Defined benefit pension schemes promise a defined annual sum to their retired participants. The set amount normally fluctuates by member based on such factors as years of service and annual income while working.
Typically, employees do not have the right to collect benefits until they have worked for the company or government for a term set by the pension plan. An employee’s rights are vested (covered by law or contract) once they have worked for that duration.
Defined benefit pension funds, particularly those of government-sponsored schemes, are among the largest institutional investors. Pension funds may invest in equities securities, debt securities, and alternative assets because they often have relatively lengthy time horizons.
As employees retire, new employees are added to the plan. If new employees are not being added to the plan, the temporal horizon of the plan will diminish over time.
In a defined benefit pension plan, the sponsoring employer promises its members (or employees) a defined amount of benefit. For example, it is extremely typical for the company to promise a yearly pension that is a specified proportion of the employee’s final pre-retirement income.
The pension may be adjusted for inflation over time. The employer will pay contributions to the pension fund to honor the promise. Employees may also be asked to donate.
In a defined benefit plan, the employer bears the risk – in this example, that the investments made by the pension fund fail to perform as predicted. If the investments fail to perform as planned, the employer may be obliged to make further contributions to the fund.
But it is likely that pension sponsors will be unable to make the necessary contributions and that beneficiaries would not receive the benefits expected. Defined benefit plans are becoming less widespread around the globe and are being replaced by defined contribution plans.
Euro Pension Fund is the fund for a defined benefit pension plan located in Frankfurt, Germany. The plan sponsor remits money to the fund based on projections of pension benefit commitments compared with pension plan assets. Working members of the plan also pay a portion of their wages to the fund.
It has an asset management team that devises the fund’s strategy and implements it.
Defined Contribution Pension Plans
In a defined contribution pension plan, the pension sponsor normally contributes an agreed-on amount — the defined contribution — to an account set up for each employee.
Employees also often contribute to their own retirement plan accounts, primarily through employee payroll deductions.
The contributions are subsequently invested, generally in funds that the employee chooses from a list of approved funds inside the plan.
The plan gives enough options of funds to allow employees to establish a broadly diversified portfolio. The sponsor often limits the selections to a group of mutual funds sponsored by recognized investment managers. The pension plan sponsor should also guarantee that the costs levied on the funds are appropriate. At retirement, the money that has accumulated in the account is available to the employee.
In defined contribution plans, the member (or employee) takes the risk that the pension account’s investments fail to perform as predicted. This contrasts with defined benefit plans, in which the employer takes the risk.
In defined contribution plans, the employer has no commitment to make further payments if the investments perform poorly. If the retirement fund is less than projected, the employee may have to make do with less retirement income or, maybe, defer retirement.
Because saving enough and choosing the correct investments are very important, defined contribution plan sponsors are increasingly providing financial assistance to their beneficiaries or arranging for financial consultants to help guide members.
In the past, most pension plans were defined benefit pension plans. Because these plans promise defined benefits to their beneficiaries, they are expensive responsibilities for the sponsor (company) and many sponsors no longer offer them. This development explains why defined contribution pension plans are progressively replacing defined benefit plans in most countries.
Endowment Funds and Foundations
Endowment funds and foundations are also big institutional investors in many nations. Endowment funds are long-term funds of nonprofit institutions, such as universities, hospitals, and museums.
These institutions use their endowment monies to provide some services to their students, patients, and supporters. Foundations are grant-making institutions funded by gifts and by the investment income that they earn. Most foundations do not directly provide services. Instead, they fund entities that provide services in such areas as the arts or charities. Foundations often own endowment funds, which invest the foundation’s money.
Endowment funds and foundations often have a charity or philanthropic aim and accept endowments from contributors interested in supporting their activities. In many countries, gifts to these institutions are tax deductible for the donors.
That is, gifts diminish the income on which the donors have to pay taxes. Investment income and capital gains that these organisations get from investing these funds may also be tax-exempt.
Endowment funds are normally meant to remain in perpetuity and, as such, are viewed as very long-term investors. But they are also often mandated to spend annually on the benevolent or philanthropic objective for their existence, therefore money needs to be pulled from their funds.
Many endowment funds and foundations adopt spending criteria; for example, they may set expenditure goals of a percentage range of their assets. Often, their issue resides in combining long-term growth with shorter-term income or cash flow requirements.
Each endowment fund or foundation has its own special circumstances. Some are able to raise money on an ongoing basis, but others are limited from raising more money. Some endowment funds and foundations are mandated to spend a fixed part of the portfolio each year, whilst others have more flexibility to adjust spending.
These discrepancies have significance for how the institutional investor’s assets are invested. An endowment client that is barred from fundraising has to meet its financial needs from income or the sale of assets, whereas an endowment client that has no restriction on fundraising may also raise money to satisfy its financial needs.
Most institutions with endowment funds use professional investment managers to manage the funds. Some manage portions of their money domestically, in some cases through an investment management company that they control.
Governments and Sovereign Wealth Funds
Governments receive money from collecting taxes or selling bonds. When they do not have to spend this money immediately, they frequently invest it.
Some governments have accumulated significant surpluses from selling natural resources that they control or from financing the trade of goods and services. They create sovereign wealth funds to invest these surpluses for the benefit of present and future generations of their citizens.
Sovereign wealth funds often invest in long-term securities and assets. They also may purchase companies. Sovereign wealth funds either manage their investments in-house or engage investment managers to manage their money.
Non-Financial Companies
Analysts typically identify companies as either financial companies or non-financial companies.
Financial Companies
Financial companies include investment companies, banks and other lenders, and insurance organizations. These companies provide financial services to its clientele.
Non-Financial Companies
Non-financial enterprises produce items and non-financial services for their consumers.
These companies invest money that they do not presently require to run their businesses.
The money invested by non-financial companies may be invested short-term, mid-term, or long-term. The corporate treasurer usually controls the short-term investment assets. These assets often comprise cash that the company will need shortly to pay salaries and accounts payable and financial vehicles that are safe and liquid, like demand deposits (checking accounts), money market funds, and short-term debt securities issued by governments or other companies.
Long-term investments are normally managed under the leadership of the chief financial officer or the chief investment officer, if the company has one. firms often invest long term to finance future research, investments, and acquisitions of firms and goods. Companies may invest long term directly, or they may hire investment managers to invest on their behalf.
Some corporations invest directly in the shares and bonds of their suppliers and in the shares of possible merger partners to strengthen their relationships with them. Practitioners term these investments ‘strategic investments’. These types of investments are widespread in Asian countries, such as Japan and South Korea, and in European countries, such as France, Germany, and Italy.
Investment Companies
Investment businesses include mutual funds, hedge funds, and private equity funds. These firms operate exclusively to hold investments on behalf of its owners, partners, or unitholders (units refer to shares and bonds for equity and debt securities, respectively). These companies are called pooled investment vehicles because investors in these organizations pool their money for common management.
Investment companies are handled by experienced investment managers that work for investment management organizations. These management businesses often structure and market the investment companies that they manage and so function as the investment sponsors.
Mutual funds pool the assets of many investors into a single investment vehicle, which is professionally managed and benefits from economies of scale. There are thousands of mutual funds administered by investment management businesses.
Mutual funds are often classed by their investment(s). Investments eligible for inclusion may be strictly or broadly defined and based on categories of assets, geographic area, and so on.
For example, mutual funds may specify that they invest in Chinese equities identified as having growth potential, global equities, long-term investment-grade European corporate bonds, or commodities. The investment management business receives a fee for managing the fund. Although a mutual fund can be viewed as an institutional investor, the phrase ‘mutual fund’ also refers to the investment vehicle, shares of which an individual or institutional investor might hold in a portfolio.
Hedge funds and private equity funds can similarly be considered institutional investors that manage private investment pools and as investment vehicles. They are distinguished by their use of tactics outside the limits of most standard mutual funds (discussed in Course 2, Types and Functioning of Markets).
Insurance Companies
Insurance companies form another key group of institutional investor.
Insurance Companies collect premium from persons and companies they cover. Premium are required by insurance firms to offer insurance coverage for the policyholders.
Some of the premiums are deposited into a reserve fund form which insurance coverage can be paid. The premiums in the reverse funds are invested in broad portfolios of securities and assets that attempt to ensure that adequate money are always available to meet all claims.
Regulations typically impose rules to restrict the types of investments insurance firms can keep.
Insurance firms profit from the income they gain form float which is the amount money they have available to use after receiving premium and before paying claims.
There are two primary sorts of insurance businesses.
PROPERTY AND CASUALTY
Property and casualty insurance firms safeguard their insured from the financial loss caused by such catastrophes as accidents and theft.
Property and casualty insurers have short-term views and generally unpredictable payouts; therefore, they favor shorter-term assets that are more cautious and liquid.
LIFE
Life insurance firms give payments to the policyholder’s beneficiaries in the event the policyholder dies while the insurance coverage is in force.
Life insurers have longer-term time horizons and more predictable payouts and, thus, have more leeway to engage in riskier assets. They frequently invest their reserve funds, which often are extremely big, in stocks, commodities, real estate, and other real assets.
Some insurance firms give both forms of insurance.
nsurance businesses aim to match their investments to their responsibilities. For example, if they intend to make fixed annuity payments in the far future, they may invest in long-term fixed-income securities to match the interest rate risk of their assets to the interest rate risk of their liabilities.
This approach of matching investment assets to liabilities, called asset/liability matching, decreases the risk that the company would fail to fulfill its claims.
Most large insurance companies manage their investments in-house. They also may contract with investment managers to oversee specialty investments in industries, asset classes, or geographical regions where they lack expertise or access.
Investors — both individual and institutional — differ in their financial resources, circumstances, objectives, views, financial skills, and so on. These distinctions determine what services the client requires and what types of investments are appropriate for the client. Therefore, it is crucial to record information about the client and the client’s needs.
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