Korea Capital Market Institute

Institutional investors are entities who manage collective savings on behalf of small investors under a specific objective. According to this definition of institutional investors, public and private funds, life insurance and pension funds are institutional investors but banks and security companies are not.
The maturity of liabilities differs among the institutional investors. The maturity of liabilities of pension funds and life insurance is longer than that of public funds, while that of private funds fall half way between them. This means the pension funds or life insurance firms may invest in illiquid assets or assets with long maturity such as long term bonds, SME stocks, real estate, or alternative investment vehicles. It is important to note that the long-term demand base of institutional investors is a key factor for capital market development and economic growth. The relevant literature suggests that the growth of long-term institutional investors reduces risk premiums and liquidity premiums, facilitates high risk or long-term projects, and enhances corporate productivity.
This paper analyzes the effect of institutional investors on market quality.
Specifically, we analyze whether institutional investors are informed traders and whether they affected return volatility and price efficiency in the Korean stock market between 2004 and 2012. First, we find that institutional investors are informed traders in the short term. Institutional investors' net buying precedes positive stock returns and net selling precedes negative stock returns on a daily and weekly basis. This implies that institutional investors' trades include private information. Second, we find that institutional investors’ trades reduce return volatility. Previous studies suggest that informed traders enhance the discovery of equilibrium prices and therefore reduce price volatility. Results show that return volatility decreases as the portion of institutional investors' trading increases and the reverse holds true for individual investors. The volatility effect is more evident for pension funds and life insurance than public funds, which suggests that the trades of institutional investors with less liquidity constraints are more likely to be based on private information. Third, we find that institutional investors' trades enhance price efficiency. As the portion of institutional investors trades increases, stock returns follow a random walk, meaning they are unpredictable. Particularly, life insurance and pension funds' trading has significant positive impact on price efficiency. These results show the importance of information based trading for market quality.
The growth of institutional investors, supplying risk and long-term capital, expands the demand base of the capital markets, which in turn boosts economic growth. In this sense, the first policy implication is that governments should lift hurdles that prevent institutional assets from flowing into capital markets. For this, when it comes to retirement pension plans, it is necessary to improve pension fund governance, and ease the restrictions placed on investable asset types. Also, the National Pension Fund(NPF) should move its investment targets from highly liquid and large cap stocks to small cap stocks and alternative investments.
The empirical results of this study show that institutional investors in Korea so far have played a positive role in improving the quality of the capital markets. However, this role is disproportionately concentrated and carried out by the NPF, which is undesirable for the sound development of Korea's capital markets. Therefore, the policy focus should be placed on diversifying institutional investor pools. Specifically, the authorities need to develop the mutual fund industry by enhancing the link between mutual funds and retirement pension plans. Also, they should lower the entry barrier for hedge fund managers and enlarge investment pools by encouraging more small and medium funds and foundations to join.
 In addition, domestic institutional investors need to recognize the importance of reducing implicit trading costs. They usually require immediacy of execution so they bear significant price impact costs, which are estimated to be three to four times larger than those of US institutional investors. Domestic institutional investors should pay attention to reduce implicit trading costs as well as explicit trading costs because in effect these costs lower investment returns.