Effect of Institutional Investments on the Stock Market

Institutional investors, such as mutual funds and insurance companies, play an extremely important role in the stock market. Understanding the next key move of institutions can often help the individual investor guess where large quantities of money will flow. This helps the investor predict the broad trends in stocks and in most major financial sectors.

Definition

An institutional investor is a legal entity in which professional managers handle investment duties and manage funds that do not belong to them. In a mutual fund, for example, the management team is in charge of funds entrusted by individual investors. In the case of a pension fund, the money under management belongs to workers and employees. Insurance companies manage the money that has been collected from policyholders. In all cases, the people in charge of the fund have control over large pools of cash contributed by other individuals or entities.

Large Purchases

Institutions control large sums of money. Therefore, stocks that attract the attention of institutional investors tend to appreciate quickly and significantly. In fact, some institutions will only buy the stock of a particular company if they can accumulate sufficient shares to influence its strategic direction. For any shareholder, accumulating the majority of common shares in a company provides control over the election of a board of directors and therefore the management of the business. Such interest in a stock will give it a large boost. On the flip side, however, the withdrawal of such an institution from a stock will drag it down badly and can spell disaster for all holders.

Initiate Trends

Institutional investors have a long-term outlook. While many individual investors lack a clearly defined target holding period, institutions purchase shares with the intent to hold them for several years. Because their purchases are preceded by a thorough analysis, sometimes lasting years, they cannot jump from one stock to another every month. In most cases, the individuals who entrust their funds to institutions will also not need immediate withdrawals, allowing the institutions to buy and hold. Therefore, when institutions buy a stock, they initiate long-term trends. Individuals lift the share price today and drag the same stock down shortly thereafter by selling it. Institutional buys, however, tend to "stick" and establish solid and lasting trends.

Leadership

Institutional investors are the leaders in the stock market. When even a single large institution begins to accumulate a specific stock, other institutions as well as individual investors tend to take note and follow. Such interest means that the stock's issuer passed the stringent test of the institution's financial analysts and holds long-term promise. Since institutional analysts also tend to contact the company's management directly, their purchases imply the company is led by a professional and reliable management team that the institutional investor feels comfortable interacting with. Therefore, many financial publications closely follow and report changes in the behavior of institutions.