Uva Dare Digital Academic Repository The Impact Of-Books Pdf

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Institutional investors and capital, market liquidity. 4 1 Introduction, The growing presence of institutional investors in financial markets is one of the forces that. influences the way in which market liquidity is provided and sustained For this reason. we devote this chapter to institutional investors and the implications of their presence. in the capital markets We discuss the following issues What are the main differences. between institutional investors and individual investors How does the trading behavior. of institutional investors affect capital markets and equity markets in particular How do. institutions behave as shareholders What consequences does this have for their impact on. the liquidity of equity markets Most of our attention is devoted to equity markets as they. are also the subject of our empirical research The aim of the chapter is twofold First. to illustrate the most important properties of institutional investors Second to present. some empirical evidence on the impact of institutional investors on capital markets and. their liquidity, Institutional investors have probably represented one of the most dynamic parts of the. global financial services industry in the last decade 1 We observe a substantial and in. creasing flow of funds into almost all types of institutions 2 Institutional investors are. specialized financial institutions that collect savings and manage them on behalf of indi. vidual investors Institutional investors operate as pooled investment vehicles and allow. individual investors to participate jointly in the pool of investments without directly par. See Davis 1996 Gruber 1996 Vittas 1998 and Walter 1999 among others for a discussion of. the recent growth of institutional investors and their future role within the financial system. See OECD Financial Market Trends June 2000, 42 Chapter 4 Institutional investors and capital market liquidity. ticipating in the capital markets, Statistics show that the degree of financial intermediation undertaken by institutional in.
vestors rose sharply over the last three decades The average annual growth rate of financial. assets of institutional investors in the OECD area exceeded 10 in the period 1990 1996. In almost half of the OECD countries the financial assets of institutional investors already. represent more than 80 of their annual GDP Part of the increased level of financial. intermediation by institutional investors probably occurred at the expense of banks whose. share in financial intermediation has been declining Institutional investors became close. competitors of banks in most of the services that banks traditionally provided For ex. ample money market funds entered the liability side of banking business by attracting. deposits from investors They also perform some functions in clearing and settlement of. payments At the same time the high growth asset management industry also attracts. competition from universal commercial and investment banks. The increased importance of institutional investors is also reflected in academic research. Many aspects of institutional investors presence in the capital markets have become the. subject of empirical investigation their investment horizon their herding their impact on. share prices and market volatility their performance etc The theory of ownership structure. provides indirect implications for the impact of institutional and other large investors on. capital markets by studying the free rider problem Schleifer and Vishny 1986 and the. effect of large shareholder activism on the value of firms Huddart 1993 Burkart et al. 1997 However studies of the impact of institutions on market liquidity are scarce. In this chapter we review the literature that is relevant for the study of the relationship. between institutions and market liquidity, The chapter is organized as follows In Section 2 we define the functions of institutional. investors we review their main types and we look at how they are organized We also. discuss the differences between institutional and individual investors We review the em. pirical evidence on the impact of institutional investors on the liquidity of equity markets. in Section 3 We look at the implications of institutional trading and institutional own. ership on market liquidity We also discuss the implications of the increased institutional. ownership for the corporate governance of the firms Section 4 concludes. See OECD Financial Market Trends February 1999, For example during the 1950 1993 period the share of US financial assets held by commercial banks. decreased from 51 to 25 while the share of mutual funds alone increased from 1 to 9 Swamy et. 4 2 Types of institutional investors and their organization. 4 2 Types of institutional investors and their organi. In this section we briefly describe the most important features of the mam types of in. stitutional investors We emphasize the common elements in their behavior and contrast. them with individual investors We focus on the non depositary institutional investors. We discuss mutual funds in more detail for they are central in the empirical analysis set. out in Chapters 6 and 7, Institutional investors are financial intermediaries they issue securities based on the sav. ings they collect from individuals and invest the proceeds in financial assets They buy. securities in the primarv and secondary public markets or purchase large blocks of securi. ties directly from the issuers in the private placements For individual investors institutions. provide a form of risk pooling on the one hand and risk diversification on the other In ad. dition institutional investors perform maturity intermediation transfer financial resources. and process price information, The investment behavior and objectives of institutional investors depend primarily on. the nature of their liabilities While institutions are exposed to the same types of risks. when they invest in financial assets the nature of their liabilities differs and dictates their. investment strategies along with regulatory considerations Liabilities of institutional. investors in general differ with respect to the uncertainty of the timing of cash outlays. and the amounts of cash outlays 5 The nature of liabilities determines the type of an. institutional investor, 4 2 1 Types of institutional investors.
Institutional investors encompass depositary institutions insurance companies pension. funds investment companies and endowment funds 0 In this dissertation we are only. interested in the non depositary ones With respect to the transparency of an institu. tion s assets and liabilities we can distinguish more opaque institutions such as insurance. companies and pension funds and more transparent institutions like mutual funds Ross. Institutional investors come in different shapes and sizes so that they can target specific. Not all financial institutions face liabilities think of investment companies for example Money. managers of such institutions are evaluated according to some pre determined benchmark In order to. outperform the benchmark they can either follow active investment strategies or simply index then. portfolios by matching the structure of the benchmark portfolio and remain passive. By endowment funds we mean private schools museums hospitals and foundations see Fabozzi. 44 Chapter 4 Institutional investors and capital market liquidity. investor clienteles with specific preferences and liquidity needs Figure 4 1 illustrates the. main types of non depositary institutional investors and the organization of their asset. management functions excluding insurance companies It also shows how retail and. private clients can access the capital market via mutual and pension funds or by employing. the financial advisors respectively As we can see from the figure institutional investors do. not necessarily perform asset management in house Just like private clients institutions. can employ outside managers consultants and advisors to assist them in asset management. We briefly characterize the three main types of institutional investors i e insurance com. panies pension funds and investment companies below h. CAPITAL MARKET, liinkmg S curit s, Deposits Commercial paper. Loan ln esonent grade boncfc, participations Equities. Pnvjte placements, Venture capital, Private equity. Asset Fund, Mmagers Consultants, Eelined Benefit, Mitual Funds Pensions Plans. Closed Open EtefinedContributiot, end end Pension Plans.
Financial Foundations, Cliends Endowments, Private reserves. Private Clients, Figure 4 1 Asset management functions of institutional investors Source Walter 1999. Insurance companies are financial intermediaries that pool risks For a price they will. make a payment to the beneficiary if a certain event occurs There are two main types. of insurance companies life insurance companies and casualty and property insurance. See for example Coffee 1991 and Walter 1999 for an overview of different types of institutional. investors and their differences across countries, This subsection builds on Fabozzi 1999. 4 2 Types and organization of institutional investors 45. companies Their key difference is in the difficulty of projecting the payoff and magnitude. of a policy, Pension funds are established for the payment of retirement benefits They are financed. by the contributions of the employers and or the employees They can be sponsored by. corporations governments and labor unions Two types of pension funds are widely. in use defined contribution plans and defined benefit plans Hybrid plans gained some. support recently Pension funds can be managed by the plan sponsors themselves or by. external asset managers Among the latter insurance companies and mutual funds are not. uncommon The portfolio structure of pension funds is regulated Their regulation differs. between the types of plans their sponsors and between countries. Investment companies sell their shares to the public and invest the proceeds in securities. Each share that they sell bears the proportionate interest in the fund s diversified port. folio The choice of securities can be restricted to specific types of assets such as shares. bonds money market instruments etc Investment companies follow a variety of invest. ment strategies depending on the pre stated objectives We can distinguish three types. of investment companies open end funds closed end funds and unit trusts The first two. are often referred to as mutual funds Unit trusts issue a fixed number of ownership shares. called unit certificates that are sold and purchased only by the issuing company They. typically invest in bonds and they are not very actively managed We look at mutual. funds in more detail, Mutual funds, Mutual funds have designed a variety of portfolio structures fee arrangements and dis.
tribution channels see Walter 1999 In general we distinguish among open end and. closed end mutual funds With respect to the characteristics of the shares that their fund. managers invest in mutual funds can further be characterized according to a number of. investment styles like growth funds value fund large caps fund small caps funds etc. Open end funds are under continual pressure as their investors may redeem their shares. and take the money elsewhere at any point in time Furthermore they are continually. ready to sell or purchase their shares at their net asset value Trading by open end mutual. funds most directly depends on the liquidity needs of their investors who withdraw assets. directly from the fund Because mutual funds typically have to sell and buy assets when. ever they face redemptions or purchases of fund units they are usually characterized as. noise traders Such trading results in a disproportionate contribution of institutions and. in particular mutual funds to market liquidity Open end funds are required to report the. net asset value per unit on a daily basis The net asset value of a unit of fund is calculated. as the market value of the fund s portfolio less the fund s liabilities divided by the number. of outstanding units, 46 Chapter 4 Institutional investors and capital market liquidity. Closed end funds sell shares like any other corporation Shares of closed end funds are sold. either on an organized exchange or in the over the counter OTC market The price of. a closed end fund s share is determined by the demand and supply The closed end form. protects the funds from liquidity shocks that their investors are subject to Holders of. shares of closed end funds can only sell their shares in the organized market like the stock. exchange or OTC market However the closed end form lacks the built in monitoring. mechanism that prevents fund managers from engaging in trading and other activities that. are not beneficial to the fund s owners, The observed differences in the growth of mutual funds across countries are strongly corre. lated with the relative importance of equity mutual funds and the performance of national. stock markets Countries with the highest growth of mutual fund assets also experience. high growth of equity funds and have the most developed stock markets In the US for. example equity mutual funds held 18 of all US equities at the end of 1999 Nanda et al. 2000 and the total mutual fund assets accounted for over half of market capitalization. in the US There are important differences between countries but the use of mutual funds. support recently Pension funds can be managed by the plan sponsors themselves or by external asset managers Among the latter insurance companies and mutual funds are not uncommon The portfolio structure of pension funds is regulated Their regulation differs between the types of plans their sponsors and between countries

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