The needs of investment clients vary widely but we can group investors into two broad categories – individual investors and institutional investors. Different investors will have varying investment time horizons, tolerance for portfolio risk, income needs and liquidity needs.
Individual investors may be investing for short-term or long-term goals. A short-term goal may be their children’s education or the purchase of a house. Longer-term goals center around providing income for retirement. These differing goals mean some investors are focused on capital growth and look for those investments with a potential for capital appreciation while retirees will want income-producing assets. The structuring of a portfolio for an investor will also be dependent on their financial circumstances like home-ownership, employment prospects, and other financial obligations.
There are many different types of institutional investors. By size, institutional assets make up a major portion of investment market participation. Pension funds, endowments, charities, banks, insurance companies, investment funds and Sovereign Wealth Funds (SWF) are all classified as institutional investors. These institutional investors also have differing financial objectives.
Endowments and Foundations
The typical objective of an endowment or foundation is to maintain the real (inflation-adjusted) capital value of the fund in perpetuity as well as generate income to provide financial support for their beneficiaries.
Banks hold deposits and make loans which can lead to excess reserves – this is where the bank holds more deposits than it has extended loans. Banks can invest these reserves which typically have to be held in conservative and liquid assets like fixed-income and money market instruments. The objective of the bank is to earn a rate of return in excess to the rate of interest it pays on its deposits.
Insurance companies receive premiums from the insurance policies they write. They need to invest these premiums to ensure there are sufficient funds available to pay for insurance claims when these arise. As such, their investments are also often conservative in nature and cognizant of the investment time frame over which claims may arise.
Investment companies manage mutual funds which are pooled investment vehicles. Mutual funds are seen as an efficient way for individual investors to gain access to a diversified portfolio and benefit from the skills of a professional investment manager. Mutual funds are managed according to the limits and restrictions of their investment mandates.
Sovereign Wealth Funds
SWFs are government-owned investment funds. Some operate with the objective of investing the revenues from the natural resources of the country (i.e. oil) for the benefit of future generations of citizens while others manage the assets of the state.
Excess reserves held by banking institutional investors are usually invested is:
A. Emerging market equities and other high-growth stocks
B. Money-market and fixed income instruments
C. Real estate and other tangible assets
The correct answer is B.
Banks invest their excess reserves in conservative and liquid assets such as fixed income and money-market instruments.
Reading 51 LOS 51b:
Describe types of investors and distinctive characteristics and needs of each