An institutional client is an organization that invests on behalf of others.
Learn about the role of an institutional client in institutional investing along with the types of clients and what sets them apart from retail clients.
What Is an Institutional Client?
An institutional client is a large organization that gathers money from its members or shareholders and invests it on their behalf. Major institutional clients are known as Wall Street’s “smart money” because they tend to have more knowledge and resources to evaluate company and market trends than your average mom-and-pop investor. That said, they may opt to invest their assets indirectly through a more experienced asset manager, or, if they have the financial expertise to do so, invest directly.
- Alternate name: institutional investor, institutional end investor
How an Institutional Client Works
Institutional investing typically involves three players:
- Asset owners: These are the institutional clients, or to be more specific, their board members, who own and administer the funds in a particular asset plan. They make choices about how to allocate the assets of members or shareholders based on their investment goals, market trends, and laws and regulations. Many clients outsource the deployment of assets to an asset manager, but some manage their assets themselves, removing the asset manager from the equation.
- Asset managers: These are typically investment managers who act as a fiduciary to and manage the assets of institutional clients by making investment decisions in accordance with regulations.
- Intermediaries: These are investment consultants that institutional clients enlist to help make asset-management decisions and supervise investment managers. They're particularly useful when institutional clients lack the relevant in-house expertise to perform these activities on their own.
Let's take the example of a pension fund. The institutional client sets up a pension plan for its employees. It then accepts contributions from its employees and sets them aside. To meet its objective to grow the assets in the pension for use in the employees' retirement, it opts to invest the assets on behalf of the employees. It lacks robust asset-allocation expertise in house, so it enlists an institutional investment consultant to make decisions about how to invest plan assets and whom to hire as an investment manager. It then hires the recommended investment manager to implement the recommended investment approach.
Institutional investing is a triangular relationship between asset owners, asset managers, and intermediaries, where institutional clients act as asset owners.
Types of Institutional Clients
There are several kinds of institutional investors, each with different investment objectives:
- Mutual funds: These are companies that pool money from a group of individuals and invest it in stocks, bonds, and other securities. The individuals, in turn, become shareholders in the company. Investment objectives vary by fund type. Growth funds invest with an eye toward capital appreciation, bond funds seek to generate income, and balanced funds aim for a combination of both.
- Pension funds: These include public funds set up by public entities and corporate pension funds set up companies. They seek to provide retirement income for plan participants, and as such, invest in such a way as to produce income but also meet their debt obligations.
- Endowment funds: These are funds established by non-profit organizations, universities, charitable trusts, and other organizations. As they aim to support the objectives of an organization, they invest to maximize long-term returns but also preserve the principal.
- Insurance companies: These include firms that provide life, health, and other types of insurance. As in the case of pension plans, insurers aim to generate income and meet their liabilities.
- Banks: These financial institutions pool equity capital from shareholders, gather additional deposits, and invest the cumulative money into balance-sheet assets. Their investment goals are the same as those of insurance companies.
- Hedge funds: These funds pool money and invest it similarly to mutual funds but are less regulated and tend to come with greater risks in exchange for potentially greater returns.
Institutional Clients vs. Retail Clients
|Institutional Clients||Retail Clients|
|Invest on behalf of others||Invest for themselves|
|Have advanced knowledge of financial markets||Lack advanced financial knowledge|
|Engage in high-volume trading||Trade at lower volumes|
|Use advanced tools such as algorithms||Don't have advanced tools at their disposal|
In contrast to institutional investors, who buy or sell securities on behalf of others (and oftentimes through others) using above-average financial acumen, retail investors or clients represent individuals who don't have advanced knowledge of financial markets and buy or sell securities for themselves.
They transact through brokerage firms or investment banks and may solicit advice from investment advisors in the way that institutional clients rely on investment consultants. But not all of the securities available to institutional clients are available to retail clients (for example, some mutual funds or mutual fund share classes are only available to institutional clients, and hedge funds tend to be restricted to all but the wealthiest investors).
Institutional shares of mutual funds are sometimes available to retail investors through employer-sponsored retirement plans.
Lastly, when retail clients do buy and sell securities, they tend to do so at much lower volumes than institutional clients. The latter may use sophisticated algorithms and electronic trading platforms to engage in high-volume trading.
- An institutional client or investor is an organization that invests on behalf of others.
- The client serves as the asset owner in an institutional investment arrangement that also features asset managers and intermediaries.
- Six major types of institutional clients are mutual funds, pension funds, endowment funds, insurance companies, banks, and hedge funds. Each type follows a different investment approach.