Exploring Different Types of Investors | CFA Level I Portfolio Management

In this lesson, we’ll introduce different types of investors and highlight their unique characteristics and needs. We’ll focus on four main characteristics: investment horizon, risk tolerance, income needs, and liquidity needs.

Individual Investors: From Youngsters to Retirees

Individual investors save and invest for various reasons, such as buying a home, funding children’s education, or planning for retirement. Depending on their life stage, their needs will differ:

• Young individuals: These investors usually have a long investment horizon and high risk tolerance, with low income and liquidity needs. They tend to seek assets with strong capital gains potential, like growth stocks and commodities.
• Retirees: With a shorter investment horizon and higher income and liquidity needs, retirees have a lower risk tolerance. They may invest in fixed-income and dividend-paying stocks.

Institutional Investors: A Diverse Landscape

There are various types of institutional investors, including defined benefit pension plans, endowments, foundations, banks, insurance companies, investment companies, and sovereign wealth funds. Let’s take a closer look at each.

Defined Benefit Pension Plans

In defined benefit pension plans, employers commit to paying a fixed annual amount to employees upon retirement. The employer assumes the investment risk and must contribute enough to ensure the fund can provide promised future benefits.

Young companies with a young workforce have a long investment horizon, high risk tolerance, and low income and liquidity needs. Meanwhile, mature companies with more retirees have a shorter investment horizon, higher income needs, and lower risk tolerance. Their liquidity needs remain low.

However, defined contribution plans differ, as employees assume all investment risk and make their own investment decisions. The employer only makes regular contributions to the employee’s retirement account.

Endowments and Foundations

Endowments and foundations are funds dedicated to providing ongoing financial support for specific purposes. Both typically have long investment horizons, high risk tolerance, and low liquidity needs, apart from their planned spending.

Banks

Banks accept deposits and extend loans. Banks may also invest their excess reserves, which are deposits that have not been used to make loans. However, the bank has to maintain sufficient liquidity to meet unexpected surge in withdrawals from depositors.  The investment horizon is short and banks are typically conservative investors, seeking low-risk investments in the form of fixed income and money market instruments that are sufficiently liquid.  They have short investment horizons and focus on low-risk, liquid investments like fixed income and money market instruments.

Insurance Companies

Insurance companies invest policy premiums to pay future claims. Their investment approaches are relatively conservative due to high liquidity needs to meet claims obligations, which can be unexpectedly high. Non-life insurance companies have shorter investment horizons compared to life insurance companies as their claims are expected sooner.

Investment Companies and Mutual Funds

Investment companies that manage mutual funds pool investor capital to diversify and leverage the skills of professional managers. The investment horizon, risk tolerance, and income needs vary by fund type, with high liquidity needs to meet investor redemptions.

Sovereign Wealth Funds

Sovereign wealth funds are pools of government-owned assets that may invest in various ventures, like managing foreign exchange reserves or investing revenues from natural resources.

And there you have it – a quick overview of the investment characteristics of the different types of investors: