Institutional investors are the big money in the market. Wall Street whales control the vast majority of funds, financial expertise, and influence, which leads many to believe that they outperform the economy and regular investors. Well, do institutional investors beat the market? Today’s article will analyze the data and provide a detailed and decisive answer.
What is institutional investing?
What is an institutional investor?
Unlike institutional investors, retail investors are individuals investing their own money, either directly or through a broker. Since they have limited funds and no access to sophisticated knowledge and software, retail investors are thought to be less successful than their institutional competitors.
How influential are institutional investors? In fact, they are responsible for more than 90% of the market’s stock trading volume. Furthermore, they enjoy lax regulation, they can enter exclusive markets (known as ‘dark pools’), and they can invest in private equity, such as pre-IPO stocks.
Smart money
We’ve mentioned how institutional investors enjoy a more favorable reputation compared to retail investors. Their financial outreach is dubbed ‘smart money’ and refers to institutional investors’ behavior, funds flow, and supply and demand of capital.
If you’re interested in tracking institutional investors, we recommend Finbold Signals, which allows you to monitor institutional moves, helps you align your investing strategies with the smart money, and delivers workable data on well-timed transactions.
Do institutional investors beat the market based on data?
While the question seems simple, the answer is decidedly complex.
There are well-known stories of success out there, with some stock portfolio managers achieving enviable profits just by betting on the right horses. What is less known is that there are fewer of them each year.
“Every year, S&P Dow Jones Indices does a study on active versus passive management. [In 2019], they found that after ten years, 85% of large-cap funds underperformed the S&P 500, and after 15 years, nearly 92 percent are trailing the index.”
—Larry Swedroe, CRO for Buckingham Wealth Partners and author/co-author of 18 investment books
Swedroe and various other experts point out that the market has evolved to bring market price and intrinsic worth closer together, reducing the difference between these two types of value. In short, they argue that the market is much more efficient and that there is less undervalued or overpriced equity.
Likewise, the growing number of institutional investors over the last few decades has introduced more competition and reduced their profit margins. According to this study, in 1940, the net purchases by institutional investors amounted to just $100 million (almost negligible compared to total trading volume). In the 1950s, institutional stock trading volume was approximately 10% of total stock market activity. This number is over 90% today, so institutional competition is fierce.
Active vs passive fund performance
Each year, the S&P DJI publishes the findings of its SPIVA research on the profitability of active stock management compared to passive investing. The results? It has consistently concluded that the number of active managers outperforming passive indices over any given time is very low.
They are not the only ones with that conclusion. Warren Buffett, one of the most famous investors ever, has championed passive investing and famously proven in 2007 that a humble S&P 500 index fund outperforms any actively managed fund over ten years. Between 2008 and 2017, his index fund gained 125.8% on average, while the closest actively managed fund peaked at 87.7% on average.
| Year | Fund-of-Funds A | Fund-of-Funds B | Fund-of-Funds C | Fund-of-Funds D | Fund-of-Funds E | S&P 500 Index Fund |
| 2008 | -16.5% | -22.3% | -21.3% | -29.3% | -30.1% | -37.0% |
| 2009 | 11.3% | 14.5% | 21.4% | 16.5% | 16.8% | 26.6% |
| 2010 | 5.9% | 6.8% | 13.3% | 4.9% | 11.9% | 15.1% |
| 2011 | -6.3% | -1.3% | 5.9% | -6.3% | -2.8% | 2.1% |
| 2012 | 3.4% | 9.6% | 5.7% | 6.2% | 9.1% | 16.0% |
| 2013 | 10.5% | 15.2% | 8.8% | 14.2% | 14.4% | 32.3% |
| 2014 | 4.7% | 4.0% | 18.9% | 0.7% | -2.1% | 13.6% |
| 2015 | 1.6% | 2.5% | 5.4% | 1.4% | -5.0% | 1.4% |
| 2016 | -3.2% | 1.9% | -1.7% | 2.5% | 4.4% | 11.9% |
| 2017 | 12.2% | 10.6% | 15.6% | N/A | 18.0% | 21.8% |
| Final Gain | 21.7% | 42.3% | 87.7% | 2.8% | 27.0% | 125.8% |
| Average Annual Gain | 2.0% | 3.6% | 6.5% | 0.3% | 2.4% | 8.5% |
The main reason? Most actively managed funds take a 2% fee and 20% of the profits while passive investing’s costs are significantly lower.
Academic opinion
‘In general, absent any inside information, an equity investor can expect to do better by holding a well-diversified, low-fee, passive index fund than by holding a few stocks.’
The results were the following: 36% agreed, 57% strongly agreed, and 7% did not answer. Not a single responder disagreed (0%).
How many institutional investors beat the S&P 500?
A few institutional investors do beat the S&P 500 every year. However, most do not.
According to the previously quoted SPIVA’s research, out of 1121 funds confirmed at the end of December 2015 in the U.S., only 317 survived their first year, 109 lasted for two years, 70 reached the end of their third year, and only 43 survived into the beginning of their fifth year, which is only 3.83%.
That said, a couple of the most successful institutional investors still beat the S&P 500. If you manage to track the right one, so will you.
Why invest in hedge funds if active fund management does not beat the market?
Here comes the catch: hedge funds aim for absolute returns rather than outperforming a benchmark or the market. As is known, the economy does not expand every year, and passive investing tends to reflect the performance of the portion of the market it tracks.
In other words, your passive investment will fail if the market experiences a downturn.
As their name indicates, hedge funds hedge the pooled assets to provide an absolute return, disregarding the broader market’s performance. Its managers aim for positive returns in all market conditions, exploiting inefficiencies and creating value even in down markets, usually by shorting vulnerable equity.
There are other advantages to sticking with active fund management and institutional investing:
- Diversification. Hedge funds often rely on alternative strategies unavailable to other investors, such as short selling, leverage, arbitrage, or derivatives. These methods hedge against market failures, diversify exposure, and increase the resilience of your portfolio;
- Sophisticated expertise. Hedge funds employ seasoned managers with expertise in advanced investment tactics, providing a high level of skill and strategic insight;
- Niche markets. Hedge funds can invest in niche markets and financial instruments that are usually inaccessible through passive investment funds, such as emerging markets, pre-IPO stocks, and sector-specific positions. These are typically unrelated to the broader market, allowing for diverse return potential;
- Alignment with ‘smart’ money. As sophisticated institutional investors, hedge funds have a minimum investment requirement and undergo less restrictive regulations. As such, they cater to wealthy individuals or institutions seeking custom-tailored investment strategies and high reward potential that they assume is worth the risk.
The bottom line
So, do institutional investors beat the market? The short answer is that, on average, they don’t, but there are a few who can outperform.
If you have caught the right candidate, consider monitoring its market activities with an institutional tracker like Finbold Signals. Our tracker can deliver relevant reports and notifications about significant institutional investing developments in the shortest time when they matter the most.
Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
FAQs
What is an institutional investor?
Institutional investor is a company or organization that pools funds and invests that money on behalf of other people in various assets and financial instruments, including stocks, bonds, real estate, and others.
Do institutional investors control the market?
Institutional investing makes up more than 90% of all stock trading volume. While institutional investors have no direct influence on the market, the sheer scale of their market presence profoundly impacts the market.
Do institutional investors beat the market based on data?
Based on scientific research and available data, institutional investors fail to beat the market on average. However, a select few institutional investors always manage to outperform their benchmark index and the broader market.
What percentage of investors beat the market?
In the long run, the percentage of actively managed funds that beat the market is markedly low. According to research, only 3.83% of actively managed funds survive its fifth year.
How to track institutional investors?
To track institutional investors, we recommend Finbold Signals, which delivers the right information about the relevant institutional investing developments in real-time.
What is the concept of smart money?
“Smart money” refers to institutional investing and the behavior, flow, supply, and demand of institutional capital. Many retail investors believe that tracking smart money and monitoring its effects can benefit their investments.
