Anatomy of institutional investors: Preferences, performance, and clienteles

Institutional investors have played an increasingly important role in financial markets over the years. By the end of 1998, institutional investors accounted for 59% of the ownership of the U.S. equity market. To understand their identities, investment behavior, and portfolio performance, a detailed anatomical study of the five major groups of the institutional investment universe is conducted: bank trust departments, insurance companies, investment companies, investment advisors, and endowment and pension funds. Using the legal framework for each institutional investor group, the effects of prudent man laws and fiduciary duty regulations on portfolio choices of institutional investors are analyzed. In particular, the investment preferences and portfolio allocations of each institutional investor group are examined. Using advanced portfolio performance measurement methodologies, the equity investment performance of each of the institutional groups is investigated. Finally, in order to study institutional investor clienteles, the reaction of institutional investors to changes in dividend policy is examined. Results support the hypothesis that legal structure has a significant impact on the investment behavior of institutional investors. Institutional investors governed by prudence-based investment regulations are found to manage the safest portfolios and show the best investment performance in the institutional investment universe. Results also provide support for the existence of institutional dividend clienteles. Implications of the findings for U.S. and world equity markets are discussed and suggestions for future research proposed.