Whenever the stock markets see bull or bear rallies, it is immediately linked to the heavy institutional buying or selling. Institutional investors are legal entities that create huge pockets by pooling investors’ money. At the same time, they have to invest this pool further to provide good returns to their investors.
When such institutions invest money, it is called institutional investment. What kind of institutions are called institutional investors? The most common examples are Mutual Funds, Hedge Funds, Pension Funds, Insurance Companies, Commercial Banks, Credit Unions, Co-Operative Banks, etc.
Based on the location of the institutions, they can be grouped as Domestic Institutional Investors (DIIs) or Foreign Institutional Investors (FIIs). For Ex: LIC is a DII for India. But, if it invests in the US markets, it becomes an FII for them. Here’s how Institutional Investments work and the risks they face.
Overview of Institutional Investments
Institutional Investors are legal entities that collect money from investors in the form of deposits, subscriptions, or insurance premiums. In return, the investors expect high earnings on investments. Hence, these institutions employ experienced financial planners to manage their investment portfolios.
Due to the huge pocket size, institutional investments carry a great influence on the stock markets as well as the money markets. As a result, they are popularly called the market makers. The investments made by the institutions are called Assets Under Management (AUM).
So, where can Institutions invest the money? Or in other words, what is the asset allocation of institutional investors? Institutions have dual investment objectives to earn higher returns and, at the same time, protect the investors’ money. Here is the list of investments where DIIs usually invest:
Institutional Traders in Equity Stock Markets
Bonds & Government Securities
Lend money to Corporates
Institutional Lenders with Peer-to-Peer Lending platforms
Fixed & Corporate Deposits
Money Market Instruments like Treasury Bills, Commercial Paper, etc.
Unlike individual retail investors, DIIs hold the power of capital. Hence, they can invest in valuable assets which are costly and scale their investments to earn higher returns. How much an institution allocates in fixed income securities and equity investment depends on the objective and risk tolerance.
Types of Institutional Investors
Having understood what are Institutional Investors and how they work, here are the types of Domestic Institutional Investors in India:
Banks receive savings and term deposits from investors and lend the money to individuals or corporates to earn interest income. Hence, they are the major Institutional Lenders. The depositors earn interest on their deposits and also benefit from compounded returns on term deposits.
Investors can subscribe to the fund by purchasing its units. Mutual Funds then invest the money in equity and debt securities to earn income. Investors receive dividend payouts from the fund and also earn from the increase in the value of the AUM.
Insurers cover the policyholders against the payment of premium. This premium amount is invested. Based on the type of insurance, the policyholders get the insurance cover, or sum assured at the end of the policy, or return on investments in the case of ULIPs.
Similar to Credit Unions in the West, Co-Operative banks in India are created to provide access to easy credit in rural areas. The major objective of these institutions is to help the agricultural population by providing higher interest on deposits and providing credit on easier terms & conditions.
They are purely institutional traders whose sole purpose is to earn higher returns for the investors so that any probable losses can be covered. Traditionally, hedge funds worked on a long-short equity model to create a safety net for investments, but now they focus on earning higher returns to compensate for losses.
Real Estate Investment Trusts (REITs):
Similar to Mutual Funds, investors can purchase REITs from the stock exchange. These REITs use the pooled money to invest in properties like complex & office buildings, hotels, hospitals, fiber cables, cell phone towers, etc. The investors can receive regular dividends from the REITs as well as capital appreciation.
Risks Faced by Institutional Investors
Just like Stock Markets, Institutional Investors also face internal as well as external risks. Here are the key risks faced by the DIIs:
- Management Risk: Institutional Investments are managed by experienced Investment Bankers and Fund Managers. But, the future performance of a fund manager cannot be guaranteed based on past performance. There is always the risk of a bad investment decision made by the management.
- Investment Objective: Institutional investment depends on the objective of the investors. If the investors want higher returns, the risk associated with investments is bound to be higher. As a result, there are higher chances of loss as well. It can be tricky for the fund managers to manage the risk and returns well.
- Market Risk: The return on Stock market investments is dependent on the price volatility. As a result, the Institutional traders face market risk. If the stock prices fall, investors incur heavy losses.
- Political Risk: The markets all over the world have been affected due to the pandemic followed by the Russia-Ukraine war. It has led to a rise in inflation and overall costs of operation. Hence, a country’s, as well as the larger geopolitical instability, can affect the returns adversely.
- Economic Risk: Who can forget the economic recession that followed the famous US sub-prime crisis of 2008. All the economies around the globe had to suffer losses. In such a scenario, where the international markets are crashing, it is hard for institutional investments to provide positive returns to investors.
How can P2P Lending Help Institutional Investors?
Peer-to-Peer lending is the process of direct lending where investors can register on the P2P website and lend money to individuals or small businesses. In return, investors receive monthly repayments from the borrowers, including the principal and interest amount. This reinvested money can be on the platform to earn a compounded return on investment.
Both individuals and Domestic Institutional Investors can invest money using P2P websites. But why should Institutional investors opt for P2P lending? Here are the main reasons to select P2P lending:
P2P websites do not have huge operational costs. Hence, most of the interest amount received from the borrowers is passed on to the investors. Institutional lenders and investors can thus generate high-interest returns for their depositors through P2P investments.
P2P websites allow you to invest in multiple borrowers, i.e. you can diversify your investments to reduce the default risk.
The return on investment for P2P is not dependent on the market price, which is the case with stock investments. As a result, P2P lending is free from any market risk, and volatility. P2P is associated with a certain degree of risk of default from the borrowers.
Reduces Management Effort:
Institutional investment is managed by experienced fund managers who have to extensively evaluate various investment options to choose the best alternative. With P2P websites, this effort is highly reduced because the platform complies with the RBI regulations and evaluates the borrowers on various levels before listing them on the website. Additionally, the auto-invest facility can help you earn passive income and manage your investments on auto-pilot.
P2P lending looks to emerge as one of the best investment options for Domestic Institutional Investors. If you are an Institutional investor and want to invest using P2P websites, you should consider LenDenClub.
It is one of the leading P2P platforms in India and provides high returns of up to 12% p.a. LenDenClub assesses the borrowers based on 200+ unique sets of data points to evaluate the borrowers. As a result, the website faces default risks as low as 3-4%. This can help to balance the risk and return of institutional investments.