Institutional Investors

There is a growing importance of the institutional investors in the world financial markets. Because of the enormous financial power and influence they possess on financial markets, the institutional investors are able to exercise great influence in the movements of the prices of the financial assets and other instruments. The institutional investors are able to influence both the financial markets and the business sector due to the improved investment strategies and latest techniques of trading in the market.

The significant increase in the sophistication of their exposure and approach to trading in financial instruments and other forms of investments has given rise to a number of regulatory and supervisory requirements. These requirements relate to issues like the rationale behind the restrictions on investments and the role of the risk-management standards and systems. These issues arise both in the case of industrially advanced countries as well as developing nations (Blommestein and Funke, 1998).

Factors contributing the Development of Institutional Investors There are several factors responsible for the rapid growth of the institutional investors. Some of the important factors are described in the following section:

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1. “First, the ageing of the populations of the OECD area has produced a rising demand for retirement ‘products’ such as mutual-fund products, equity-indexed annuities, asset-backed securities, and guaranteed-equity plans by increasingly well-off and sophisticated individual investors”. (Blommestein and Funke, 1998)
2. The advancement in information and communication technology has contributed to the enhanced capabilities of the financial services industry to provide intermediation and risk-management services. The institutions are able to handle these services by handling vast flows of information that too at very high speed and at lower costs. This advancement in the technology has given rise to a wholly new range of investment products – for example products like money-market mutual funds, swaps, options and credit derivatives – which are very conveniently supported by technology based methods.
3. The deregulation of banking and financial service industries from the later part of 1980s which has increased the competition among the banks and other financial institutions is yet another factor that helped the institutional investors grow. The abolition of restrictions on the capital flows across nations and the removal of restrictions on the entry of foreign financial institutions has also developed a number of institutional investors (Blommestein and Funke, 1998).
4. “Fourth, disintermediation from banks through reduced demand for bank deposits and traditional savings vehicles has resulted in a shift in favour of more performance-oriented instruments like money-market funds and mutual funds investing in equity”. (Blommestein and Funke, 1998) Fixed Income Analysis Fixed income analysis is the process of valuing the fixed income securities or debt securities. It includes a complete analysis of the interest rate risk, credit risk and the likely changes in price in hedging portfolios.

The result of the analysis may lead to a decision to buy, sell, hold, hedge, or keeping out of indulging in that particular stock. In general the bonds issued by various government treasuries, companies or other business organizations represent the fixed income securities. There will be interest coupons attached to the bonds which will entitle the bond holders to receive interest till the date of maturity of the bonds at specified periodic intervals. While making an analysis of the fixed income securities the following issues need to be considered by the analysts to evaluate the securities concerned:

1. Whether the real interest rate is built into the yield represent the real value
2. In the case of treasury bonds whether the real interest rate is in line with the GDP expected and in the case of corporate bonds whether the interest rates are in line with the earnings growth of the companies
3. Whether there is any change expected in the real interest rates in the near future
4. Whether the risk premium built in to the yield will adequately compensate the risks associated with the securities
5. Nature and volume of the demand and supply for the bond need to be a special consideration while analyzing the security
6. A consideration of the prevailing situations of monetary and economic conditions will sustain for some more time or any major changes expected in these conditions in the near future.
7. The identification of the likely current market risks that are already built in to the premium and any other risks that are hidden and are likely to influence the value of the security is also vitally important to complete the analysis.

Measuring Performance

Normally the performance evaluation has to be done by the investor or a third party on the request of the investor and it should not be done by the portfolio manager. The frequency of the portfolio evaluation can be decided based on the time horizon of the client and the investment philosophy of the portfolio manager. However it is important that the reporting on the value of the portfolio has to be done at frequent intervals to the investors.

The performance can be evaluated broadly based on the market indices instead of using the models developed to assess based on risk and return of the portfolios. However evaluating the performance based on broad market indices suffer from the limitation that there is no control for risk involved in the investments. Performance measurement involves not only the evaluation of returns but also must integrate the other fund elements that would be of interest to the investor, like the measures of risk taken. There are other factors which are considered part of performance evaluation.

These factors include whether the efforts of the investment managers have been successful in accomplishing their objectives in terms of the returns as compared with the risks taken, the level of their performance with that of their peers, and finally whether the results of the portfolio management is due to the skill of the managers or whether they are just freak incidents out of luck. Several performance measures have been developed to arrive at the answers for these questions. Over the period these models and measures have been made more sophisticated.

It may be noted that most of these measures and models have their origin from the modern portfolio theory. The link that is prevailing between the portfolio risk and return has been established by the modern portfolio theory. The first performance indicator was developed by Sharpe (1964) in the Capital Asset Pricing Model (CAPM). This model highlighted the rewarding of the risks associated with the investments through risk adjusted ratios – Sharpe Ratio, information ratio – or differential returns known as ‘alphas’.

As a development over CAPM model, Jensen (1968) proposed another model which uses factors for assessing the performance of the portfolios. This model uses the market index as the only factor to assess the performance. However it was quickly learnt that one factor alone is not enough for making a proper evaluation of the performance of the portfolios. Therefore multifactor models have been developed as alternative performance measure to CAPM. These models allow better description of portfolio risks and more better and accurate evaluation of the performance of the investment managers.

For example the model developed by Fama and French (1993) have included two other factors that are considered important to characterize the risk elements of the company in addition to the market risk, Book-to-market ratio and the size of capitalization of the firm are the important factors considered by Fama and French (1993) who developed and proposed a three factor model for performance evaluation. Carhart (1997) added a fourth factor in the development of a custom benchmark for each portfolio.

This model uses the linear combination of style indices that best replicate portfolio style allocation and thus makes a critical evaluation of portfolio alpha. Conclusion This paper detailed the basic features of invest management including the steps involved in the process of management. The important and first step involved in the investment management is identified to be the determination of the objectives of the investment in terms of the risks the investor would like to take to achieve a specified return.

Portfolio management involving assets allocation, asset selection, market timing, rebalancing is found to be important components of the portfolio management process. Similarly selecting the proper assets is the central idea behind asset allocation. The contribution of the institutional investors with their sophisticated trading techniques and methods has helped the theory and practice of investment manage to reach newer heights in the past decades. There are various factors responsible for the development of the institutional investor.

This paper identified the ageing population of the industrially advanced countries looking for better investment opportunities, economic reforms by various countries making the functioning of the finance service industry flexible and reduced activities of the commercial banks in accepting deposits are found to be some of the factors responsible for the rapid development of the institutional investors. This paper concludes that the portfolio theory formed the basis for the development of various models for the evaluation of the performance of the portfolios.

The investors and portfolio managers use several measures and models for evaluating the performance of the investments and such periodic evaluation is considered essential for the switch in the sectoral balance of the assets in any portfolio.

References

1. Blommestein Hans J and Funke Norbert (1998) ‘The Rise of the Institutional Investor’ The OECD Observer No. 212 June/July 1998 <http://www1. oecd. org/publications/observer/212/Article10_eng. htm>
2. Citin Group ‘Investment Portfolio Management’ <http://articles. citringroup. com/Investment-Portfolio-Management. id. 688. htm>. Markowitz, Harry M. (1999).
3. The early history of portfolio theory: 1600-1960, Financial Analysts Journal, 55 (4), 5-16 Narach Investment ‘Introduction to Investment Management’ <http://www. narachinvestment. com/introduction. htm>
4. Railfoundation ‘Portfolio Management’ <http://www. rocw. raifoundation. org/management/bba/SecurityAnalysis&PortfolioManagement/lecture-notes/lecture-15. pdf>
5. Rajeev Deep Bajaj (2008) ‘Asset Allocation: Key to Successful Investing’ <http://www. ndtvprofit. com/2008/02/09120802/Asset-allocation-Key-to-succe. html>
6. Risk Glossary. com ‘Portfolio Theory’ <http://www. riskglossary. com/link/portfolio_theory. htm>

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