Investing like the pros

Pensions, endowments, and foundations are examples of institutional investors. There are a couple of significant differences in how institutions invest their assets relative to how retail investors manage theirs.

Firstly, institutional investors are very process-oriented in their approach to investing. They have a well-defined, robust process that is repeatable, and they are disciplined in following that process. Institutional investors have a target rate of return that they aim to achieve in markets over a specified period and their portfolios are constructed such that they take on the least amount of risk to capture that return. Although all investors, retail and institutional, want to participate alongside markets when markets move higher and protect capital when markets move to the downside, institutional investors are focused on their target rate of return, while retail investors can get caught up in ‘trying to keep up with the Jones’ rather than absolute returns. Investors should understand that if they protect capital in a negative return environment, their portfolios do not need to go up as much as the market in a positive return scenario and they end up further ahead.

Secondly, institutional investors have a long-term focus, that is, they do not try to time markets. They stay invested and rebalance back to their long-term asset mix on a regular basis. Retail investors tend to move in and out of markets according to the market environment and have a poor track record in doing so. That is, they invest more assets after markets have gone higher and withdraw assets after markets have gone lower. Also, the retail space chases the “winners” – that is, those asset classes or sectors that have strong recent performance and stay away from those asset classes or sectors that have performed poorly, rather than sticking with a well-defined, well-thought-out asset mix and rebalancing back to that strategic mix.

Lastly, institutional investors employ an asset mix that includes the traditional allocation to equities and fixed income but they also utilize alternative asset classes, such as Real Estate, Infrastructure, Real Assets (agricultural land, timberland) and Absolute Return strategies. Retail investors tend to use only the traditional asset classes of equities and fixed income. These non-traditional asset classes have low correlations to traditional asset classes and generally result in a better risk-return outcome for a portfolio. Also, given the low yield environment for fixed income in the marketplace today, these non-traditional asset classes can improve the realized yield within a portfolio.

Although it is important to understand that retail investors may have a much different investment time horizon than an institutional investor, retail investors should increasingly take their cue from and employ similar strategies to that of the institutional investor, participate in up markets, but protect in down markets, have a longer-term focus rather than a short-term bias and rebalance back to their strategic asset mix, while utilizing alternative asset classes to achieve their investing goals.