A Look at What Defines the “Smart Money” Advantage of Institutional Investors

January 3, 2022

Smart money, or institutional investors including a variety of institutions from pension plans, mutual fund managers and hedge funds, to banks, insurance companies and endowments, own about 80% of the US equity market cap, and that share has grown over the years. They’re so important that they have their own benchmark, the Smart Money Flow Index, which takes the pulse of institutional investors’ sentiment.

Institutional investors come in many different shapes and forms, have different structures, governance systems, and are regulated by different bodies. Their goals in investing also vary greatly, from preserving capital to meeting liabilities or maximizing earnings, based on whether their constituents are mutual fund investors, retired teachers, universities, or foundations.

The smart money advantage of institutional investors could be defined simply as influence, but that influence manifests itself in many unique ways.

They have access to companies’ CEOs.

Institutional investors have vast resources when doing research on a potential investment and unlike individual investors can easily meet with chief executives and top managers of companies. Large publicly-traded companies in the US held 124 one-on-one meetings with investors on average in 2014, according to a survey from Ipreo. In short, this means that smart money investors often have access to insider information that the public isn’t privy to. That special access makes them sophisticated investors.

They operate under different rules than individual investors.

Smart money investors can negotiate better fees on certain investments. They have access to investment opportunities that most retail investors can’t invest in, such as private equity funds that have high minimum commitment sizes. From a regulatory standpoint, they can also afford to assume greater levels of risk, leading to higher returns, simply because they have more capital.

They can move markets.

Institutional investors have access to large resources and can invest big sums, with the added bonus that quite often the money they invest isn’t theirs. Instead, they professionally invest on behalf of other people. Endowments invest on behalf of a university or a foundation. As such, they contribute to the liquidity of financial markets. They are also big market movers whether they are shorting a whole sector or buying individual stocks. If they sell large blocks of shares in a specific company, it can prompt others to sell and result in significant volatility in the stock.

They can participate in IPOs.

Underwriters tend to fill books with institutional investors who as a result have a great influence on the pricing of an IPO. Research has found that IPOs with the highest levels of institutional investment tend to fetch more attractive valuations so both underwriters and issuers seek to include a large proportion of smart money in their books.

They sit on companies’ boards.

By holding a seat on a company’s board, institutional investors can exercise a heavy influence and weigh in on shareholder voting, including proxy votes and corporate actions. Sitting on corporate boards gives institutional investors the ability to promote change. Take the conversation surrounding divestment from fossil fuels for instance.

Some institutional investors have recently pushed for greater sustainability in the corporate world and the adoption of ESG standards at companies through their influence on boards. Nearly 60% of institutional investors have a general ESG policy in place internally and that figure goes up to 85% for large investors with more than $25 billion in assets, according to HSBC’s 2021 sustainable financing and investing survey. And nearly half of all institutional investors incorporate ESG in their investment decision making processes, according to Callan’s 2021 ESG Survey.

Smart money investors tend to lead the way not only with their investment decisions but also because they start new trends in the market, making it a good idea for retail investors to pay closer attention to general trends in their moves.

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