Institutional investors are highly sophisticated organizations investing large pools of capital on behalf of other people or fiduciaries. According to the CFA Institute, global institutional investors represent more than $70 trillion in investable assets. They include pension funds, endowment funds, insurance companies, sovereign-wealth funds, and mutual funds. For example, pension funds manage retirement savings for employees, and insurance companies invest premiums collected from policyholders. With so much money on the line, institutional investors employ professional managers and analysts to make investment decisions. In addition, investment consultants provide advice to institutional investors, helping with asset allocation, manager selection, and risk management.
In many cases, institutional investors are obligated to provide guaranteed income promised to the beneficiaries such as retirees. This is commonly referred to as a defined benefit plan. They have financial obligations or liabilities in the billions of dollars annually. As such, one strategy used by institutional investors is known as liability-driven investment (LDI). Put simply, their focus is to generate income and mitigate risk. For individuals managing their own savings, including for retirement, similar goals may apply. Here are five lessons individuals can learn from institutional investors.
Diversify your portfolio.
“Don’t put all your eggs in one basket,” is an old saying that applies to investing. Diversification helps you minimize losses during a market downturn. In investments, correlation describes how two assets move in relation to each other. If two assets are not affected by the same market conditions and trends, they will be less or negatively correlated, creating diversification. By diversifying your portfolio with a mix of stocks, bonds, and real estate that don’t all move in the same direction at the same time, your portfolio is cushioned against market shocks and returns are smoothed out over time.
Carefully research investment managers.
Institutional investors choose funds and managers by evaluating quantitative and qualitative factors. Chiefly, they look at the manager’s past performance through different market cycles. This provides an indication of the manager’s philosophy for downside protection, or capital preservation. Institutional investors will interview managers and their teams to understand the experience of the team, investment process, operational infrastructure, fee structures, and the types of communication they can expect during the investment.
Adopt a long-term perspective.
Pension and endowment focus adopt a long-term investment horizon because their liabilities stretch out for decades, similar to individuals saving for retirement. Generally, individual investors can benefit greatly from having a patient mindset and avoiding emotional decisions driven by daily market fluctuations and volatility headlines. A 5-7 year holding period is a widely accepted timeframe for investors to take advantage of market cycles. This timeframe captures compounding growth and also reduces the effects of short-term volatility.
Use specialized investment managers.
Institutional investors rely on specialized managers for access to unique investment opportunities and specialized returns. Specialized managers who focus on a specific sector, asset class, or strategy develop a significant knowledge advantage and proprietary data analytics over time. They have deep networks within their sector, which help them source deals not broadly marketed, that in turn have the potential to outperform.
Rebalance your portfolio over time.
Even if you start with a diversified multi-asset portfolio at allocations you have determined to fit your investment goals, the assets will grow at different rates over time. For example, if the stock market outperforms, a 50% stock / 35% bond / 15% real estate portfolio could become a 65% stock / 25% bond / 10% real estate portfolio. When this happens, institutional investors rebalance their portfolio by selling investments that have grown overweight and using proceeds to buy assets that are underweight, often on a calendar-based (monthly, quarterly, annually) frequency. Portfolios that are not rebalanced may lose their diversification benefits over time and deviate from your intended level of risk.