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Institutional vs. Retail

While retail investors, as individual investors trading from his or her own brokerage account is a simple concept to grasp, institutional investors vary much more widely in some important characteristics. These characteristics can include the size of the investor (measured by assets under management or employees), the strategies employed, and sources of funding.

Institutional investors exist because not everyone has the time or willingness to search for the right companies or strategies to invest in. For example, a doctor who is very busy with his patients might not have time to think about his investments on a day to day business. He might prefer to put his savings with an institutional investor he likes and focus on his profession.

Mutual Funds and Insurance Companies

Mutual funds and and insurance companies have some of the largest assets under management, or AUM, on the buyside due to who their clients are. Mutual funds are a cost efficient way to invest in a diversified portfolio of companies for mom and pop. Instead of picking 50 companies ourselves, we can select a mutual fund and portfolio manager that we like and let them do the work of picking investments for a fee, often a small percentage of the assets you give them to manage.

Insurance companies often have large AUM because so many people purchase insurance. Prudential, one of the largest insurance companies in the world, has over a trillion dollars under management. An insurance company acquires its AUM when we make monthly payments to our insurance plans. However, it does not have to immediately spend that money - it only needs to spend it when accidents occur and its clients need coverage. That lag time between when it receives payments and pays them out offers an opportunity to invest that money for a return. If it did not earn any return, it would not be taking advantage of a concept we covered in a previous lesson - the time value of money.

Pension Funds and Endowments

Pensions are a form of retirement planning offered by some companies where its employees can contribute money during their employment years and have the invested amount paid back out to them in their retirement years. Just like insurance companies, companies with pensions would not just sit on idle cash, so they form funds to invest their pensions. Governments can also form pensions for their employees - an example would be the California State Teachers’ Retirement System.

Endowments of universities are built on the donations and gifts of alumni. From year to year, a certain percentage of the endowment can be spent on improving the campus, student life, and other important expenditures. However for this to be sustainable, the endowment needs to reach an investment return greater than the percentage that is spent. Because of this, endowment investment strategies are often secretive and are more flexible than traditional stock or bond funds.

Hedge Funds, Private Equity, Venture Capital

Hedge funds are more easily defined by what they are not, rather than what they are. They encompass funds that employ a variety of strategies and are relatively loosely regulated compared to insurance companies, pensions, and mutual funds. They can invest in private or public companies.

Private Equity, or PE, on the other hand invests in companies that are not listed on exchanges or traded publicly. These investors focus much more on the fundamental value of a company than other investors who might trade securities based on broad economic trends. Below is a well know PE firm.

Venture Capital, or VC, focuses on investing in companies that are in their early stages of growth and just getting off the ground. Because these companies are still relatively unproven, there is higher risk, but also higher potential reward if they succeed. A theme that appears over and over again - risk and reward.

Asset Management at Banks

Some bank holding companies have their own asset management branches. Because of the brand recognition of banks, it makes sense for them to use that to attract clients to invest with them. Some well known ones are J.P. Morgan Asset Management and Morgan Stanley Asset Management. Note that “asset management” refers to the overseeing investment decisions and allocating funds strategically while “wealth management” refers to a broader service of helping individuals with financial planning and life events.

Retail - Individual Investors

Individual Investors also have the option to invest directly in financial markets without an intermediary fund. The most popular option is to open up a personal brokerage account and invest in stocks. It is also possible to buy some bonds directly, such as US Treasury bonds, but nowadays it is more popular to invest with bond funds or exchange traded funds. Some popular brokerage accounts are offered by TD Ameritrade, Charles Schwab, and Fidelity Investments.

In recent years, a financial product called the exchange traded fund or ETF has become widely popular. This has vastly expanded the individual investor’s set of available investment options. We will discuss this product on the next page.

Exchange Traded Funds

The exchange traded fund has been around for a while, but its popularity has risen dramatically in recent years and has contributed to growth in passive investing. Investing can be classified as passive or active based on the way that investment decisions are made.

  1. Active - choosing and picking companies that one thinks will outperform the general market. It also involves more frequent trading as investment theses change with market conditions. The cost of this effort and analysis is reflected in management fees which erode returns, but can be worth it if the manager is skilled.

  2. Passive - buying and holding for the long term. This involves less frequent trading, and with the recent popularity of ETFs, it becomes easier to buy buckets of companies with a focus on certain sectors, or even entire indices, reflecting the performance of the entire market. This is often done with a view that it is hard to pick companies and outperform the stock market, so another way to save costs is to minimize fees spent on portfolio managers who might not deliver results.

Because of the way an ETF works, it offers diversified investment options with low fees to individual investors and even fund managers, where as decades earlier, one would be limited to mutual funds. ETFs can have themes that range from a broad focus to ones that are more specific like solar energy ETFs, cloud technology ETFs, social media ETFs, etc. The popularity of ETFs has raised doubt on whether it has become overdone, but few would dispute that it is a useful innovation for the average investor.


Investors come in all shapes and sizes. The strategies they deploy may be vanilla buy and hold, or esoteric with derivatives leverage and hedging, but at the end of the day, their actions combined make the market a more efficient in pricing the true value of assets. The landscape is always changing, and dominant trends in this decade like the rise of ETFs might not be so dominant in the next.