Institutional Investing,
Explained Simply

Simple Explanation

They're called "owners" because they own the assets (money/investments). Also called "investors" because they allocate capital to managers — even though they hire others to do the actual investing.

Key Point

Asset owners don't usually pick individual stocks themselves. They hire professional managers to invest on their behalf.

Examples

BlackRock, Vanguard, Fidelity — these are asset managers. They don't have their own money to invest; they invest money for pension funds, endowments, etc.

Why They Compete

More assets under management = more fees = more revenue. That's why they compete intensely for mandates from big institutional investors.

Two Types

Corporate Pensions: A company's fund for its employees (like Ford's pension for Ford workers).

Public Pensions: Government worker funds (teachers, police, firefighters). Often enormous — CalPERS manages over $400 billion.

Key Difference

Public pension decisions become public through FOIA requests, which affects how they behave.

Cookie Analogy

If you promised 100 cookies but only have 80, you're "underfunded" (short 20). If you have 120, you're "overfunded" (extra 20).

Why It Matters

Pension funds constantly check: "Do we have enough money to pay everyone we promised?" This drives their investment behavior — underfunded pensions may take more risk to catch up.

Real Example

Harvard has an endowment of about $50 billion. They use investment earnings to pay for scholarships, professors, and buildings.

Key Concept: Perpetuity

Endowments are meant to last FOREVER. They spend about 5% yearly but grow the rest. Because of this infinite horizon, they can invest in things that take a long time to pay off.

Example

The Bill & Melinda Gates Foundation has billions of dollars. They invest it to make more money, then use that money for charitable causes like fighting diseases and helping education.

Example

Norway found a lot of oil. Instead of spending it all, they saved it in the Norwegian Government Pension Fund (over $1 trillion!). Saudi Arabia, Singapore, and Abu Dhabi have similar funds.

Why They're Special

They're not just trying to make money — they might have political goals too. A country might invest in certain industries to help its own economy.

Example

The Walton family (Walmart founders) has billions. They have a whole office of people whose only job is managing the family's investments.

Why They're Different

Each family is unique. One might love risky tech investments, another might be super conservative. They can also move quickly without committee approvals.

How It Works

A pension fund's staff might not know all the investment companies out there. They hire a consultant (like Mercer or Aon) to research options and make recommendations.

Their Power

Consultants influence roughly 40% of global institutional assets. Getting on their "buy list" can unlock billions in potential business.

Like a Restaurant Guide

The consultant reviews hundreds of asset managers and creates a list of the best ones. Pension funds then pick from that list.

Why It's Powerful

If you're on a big consultant's buy list, you might get access to billions in potential business. If you get kicked off, you could lose clients across the board.

What They Do

A pension fund's CIO decides the overall strategy — how much in stocks, how much in bonds, which managers to consider hiring.

Why They Matter

When a new CIO joins, they often change things. Their relationships with asset managers from previous jobs often follow them to the new organization.

The Difference

Normal consultant: "Here are 3 good options, you pick one."

OCIO: "I'll pick for you and manage everything."

Why It Exists

Some organizations don't want to build internal investment expertise. They outsource the entire function to a specialist.

Example

If BlackRock manages money for 1,000 different pension funds, and all that money adds up to $10 trillion, their AUM is $10 trillion.

Why It Matters

More AUM = more fees = more money for the asset manager. It's a key measure of size and success.

Pizza Analogy

You might want 40% pepperoni (stocks), 30% cheese (bonds), 20% vegetables (alternatives), and 10% mushrooms (real assets). Asset allocation is deciding those percentages.

Why It Matters

Studies suggest asset allocation determines 90%+ of portfolio outcomes. It's the most important investment decision.

Example

If you buy Apple stock, you own a tiny fraction of Apple. If Apple does well, your stock becomes worth more.

Why "Equities"?

You have "equity" (ownership) in the company. The terms are interchangeable.

Example

You buy a government bond for $1,000. The government promises to pay you back $1,000 plus $50 in interest after 5 years.

Why "Fixed Income"?

Because the interest payments are usually fixed — you know exactly what you'll get.

Why They Exist

Big investors want some money in things that don't move the same way as the stock market. If stocks crash, maybe alternatives won't crash at the same time.

Examples

Private equity, hedge funds, real estate, infrastructure, private credit, commodities, and more.

Example

A PE firm buys a struggling pizza chain for $100 million, improves the operations, opens new locations, then sells it 5 years later for $200 million.

Key Difference from Stocks

You can't just sell your PE investment whenever you want. Your money is "locked up" for years.

Example

A pension fund that gives money to a PE firm is an "LP" in that PE fund.

Why "Limited"?

They have limited involvement — they give money but don't make the actual investment decisions. The PE firm (the GP) does that.

The Relationship

LPs give money → GPs invest it → Hopefully everyone makes money → GPs take a cut of the profits.

How It Works

You "commit" $100 million to a PE fund. But you don't hand over $100 million right away. The fund "calls" (asks for) the money over time as they find companies to buy.

Example

You committed $100 million. The fund finds a company to buy and sends you a capital call: "Send us $20 million by next Friday."

Why It Happens

Early years: negative returns (you're paying fees but haven't sold any companies yet). Later years: big gains (when improved companies are sold for profit).

What Makes Them Different

Short selling: Betting stocks will go DOWN (not just up)

Leverage: Borrowing money to invest more than you have

Complex strategies: Things like "if X happens, buy Y and sell Z"

Example

A company needs $50 million but doesn't want to go through a bank. A private credit fund lends them the money directly and earns interest.

Why It's Growing

Banks have pulled back from certain types of lending, so private credit funds stepped in to fill the gap.

Examples

Buildings, land, toll roads, airports, power plants, timber, farmland, oil fields.

Why Investors Like Them

They often protect against inflation. If prices go up, rent goes up, so your real estate is worth more.

Active Example

A manager studies companies and picks ones they think will beat the market.

Passive Example

An index fund buys ALL 500 stocks in the S&P 500. No picking — just own everything.

The Revolution

Most active managers can't beat the index after fees. This caused massive flows from active to passive strategies.

Example

If you invest in US stocks, your benchmark might be the S&P 500. If you earned 10% but the S&P 500 earned 12%, you "underperformed your benchmark."

Example

"CalPERS is conducting a US equity search" means CalPERS is looking for a new US stock manager.

The Process

50 managers apply → 15 make the longlist → 4 make the shortlist → 1 wins.

Finals

Making the shortlist is a big deal. These managers get to present to the decision-makers and pitch why they should win.

What Gets Checked

Track record, investment team, operations, legal issues, references from other clients, and more. It's thorough homework before handing over millions or billions.

Why It Matters

Knowing what mandates are being decided RIGHT NOW is more valuable than knowing what happened last year. Pipeline intelligence is forward-looking.

Example

Your target is 50% stocks, 50% bonds. But stocks did well, so now you're 60/40. Rebalancing means selling stocks and buying bonds to get back to 50/50.

Why It's Different

Rebalancing is mechanical and rule-based — very different from a strategic decision to change allocations.

How It Works

The CIO might want to hire a new manager, but first they need the Investment Committee to say "yes." The committee might meet monthly or quarterly to review and approve decisions.

Example

50 basis points on $1 billion = $5 million per year, whether the manager makes money or loses money.

Example

You invest $100 million. Management fee: 2% × $100M = $2 million/year. If profits are $50M, the manager keeps 20% × $50M = $10 million extra.

Why "Carried Interest"?

Historical term from shipping — the ship captain got a share of the cargo ("carried interest") as payment. Now it means the manager's cut of profits.

Example

If the hurdle rate is 8%, and the fund only returns 6%, the manager gets no performance fee. They only earn performance fees on returns ABOVE 8%.

What Happened

Index funds charge almost nothing (3-5 bps). This forced active managers to lower fees too. Twenty years ago, 1% was normal. Now investors demand much less.

Example

You negotiate 40 bps. Another pension fund negotiates 35 bps. With an MFN clause, your fee automatically drops to 35 bps too.

Why It's Valuable

A PE fund finds a great company. Normally you'd pay fees on your share. But with co-investment rights, you can invest extra money with NO fees — more exposure without the cost.

Example

A pension fund manager is a fiduciary for the teachers whose retirement money they manage. They MUST act in the teachers' best interest, not their own.

Why It Matters

Public pension funds are government entities. Anyone can request to see their investment decisions, fees paid, and manager evaluations. This affects how they behave.