Stock market activities have been always coupled with particular risks. Investing in the stock market implies accepting the risk in a way or another. In that sense, deciding on investment is based on the measurement of risk-return. Thus, in a search of a higher return, investors finance stocks with higher risks and vice versa. Therefore, the position of institutional investors in that regard can be characterized by such factors:
- Providing risk pooling, and accordingly a better trade-off of risk and return.
- Using large and liquid capital markets.
- The ability to absorb and process information, which is superior to that of individual investors in the capital market (Davis & Steil, 2004, p. 13).
In that sense, it can be seen that the first two factors can be considered results of the third one, where institutional investors can access a larger pool of information that can form certain expertise during investments. However, the same characteristics can put limits on the investment activities that institutional investors practice. In that sense, it can be said that small investors and institutional investors operate on different levels, where each of those levels has its constraints. For example, the rise of the fiduciary relationship to the ultimate investor, which might entail a degree of caution, can put limits on the institutional investors, whereas small investors are rather flexible in choosing the direction of their finances, where they even can participate in the same sector.
As stated earlier, the matter of successful investment for both institutional and small investors can be reduced to assessing risks through information. Essentially, before such assessment, the investor should define the proportion of risk and return which can be afforded. Risk-free investments are usually, on the lowest levels of return compared to other financial instruments. Accordingly, if the investor wants to receive a higher return, he would invest in operations with a higher risk rate, where the return sufficiently justifies the risk and surpasses the minimum hurdle rate. Thus, the market line of a stock is the equilibrium ratio between expected return and a systematical risk. In such a way, the small investor defines the goals in the form of, “I want to earn stable profit without taking unnecessary risks”, or “I want a single transaction that will %1000 justify my investment.” Omitting exaggeration and radical positions, it can be understood that between those two statements there are a lot of options, where the risk of losing money is proportional rises from the first statement to the second. The level of market knowledge can indicate the level of risk acceptable for each investor, and in that regard, institutional investors can act as indicators that will help assess the risks, e.g. institutional investments sales can predict market correction.
In such a way, it can be seen that deeming that investing is institutional investors’ prerogative is rather correct as well as stating that small investors are in a no-win position. The stock market opportunities are large enough for operations on a different level. In that sense, small and institutional investors can be compared to a large truck and a small car, where the large truck can take more weight, and if it is stuck, the owner can afford to leave it and buy another one. A small car can take less weight, but it is more maneuverable to taxi out.
References
Davis, E. P., & Steil, B. (2004). Institutional Investors: MIT Press.