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I hear various people saying that the lesser the number of institutional investors in the stock, the better.

Is there any reason for that thinking?

I would reason that better stocks would attract bigger players, i.e. institutional investors?

  • Perhaps institutional investors are inclined towards stocks with relatively stable prices (with earnings coming from dividends rather than from growth) and this lack of volatility is exactly what is not wanted by the various people that you are talking to who all are hoping to make a killing in the stock market if not the next day, certainly by the end of the week? – Dilip Sarwate Jun 8 '14 at 15:40
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    I would like to know who these various people are. There is no right and wrong answer to these unless we know who recommend these. You say that the pension funds who invest billions of their funds into companies are bad. These funds have a very long term view and are not like the activist hedge funds, sometimes acting like morons. And moreover a fund with a long term view is always better than an activist investor. – DumbCoder Jun 8 '14 at 15:46
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"Institutional investors" are the "elephant" in the room. When they "sneeze," everyone else "catches cold."

They're fine, if they're buying after YOU do. They're not bad, if you want to buy after they sell en masse. But when you read about moves of 10 percent, 15 percent or more in a single day, it's because a bunch of institutional investors all decided to do the same thing on the same day.

That's more volatility than most people can stomach. Fewer institutional investors in a stock mean fewer chances of those things happening.

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It's not necessarily bad but it can cause the stock price to become a lot more volatile. Depends on which side of the bet you're on ;)

Suppose a hedge fund manager thinks a company is poorly run. He may buy a ton of shares so that he can get rid of the current CEO and replace it with his/her own. For the hedge fund and others long on the stock, this is good. Those who are trading options or using some short-term strategies could get screwed because of the sudden volatility.

My next point is related to the above. What is the intrinsic value of a stock? The current price of a stock is the equilibrium of all investor's perception of the stock's value. Professionals make up a value for a stock using models such as DCF. Once they do so they trade based on what they believe the value of the stock is. You might calculate a stock is worth 70 and I believe it's 80 so the stock price is going to fluctuate a bit but it should keep within that range (assuming we're the only investors). Then comes a hedge fund manager, say Carl Icahn, and discloses a stake in our stock. "Wow, the stock must be really valuable!" Everyone starts buying this stock so up it goes to 90, simply because the guy who seems to know what he's doing bought it. The point here is that now it's not trading based on intrinsic value, now it's purely psychological. Ie. it's now a momentum stock, which you have no idea when it'll crash. Look at Tesla, Netflix, or just google momentum stocks. All the big crashes in stock prices happen when these big funds unload their stocks. A surge in supply will cut the price. The problem is you can't predict when some fund manager will decide to sell some stake of his.

Tying everything together is liquidity. The more liquid a stock is, the easier it is to obtain and the less volatile it is. The more people playing the game, with not too big shares of stock, the faster the price will converge to some equilibrium and with less volatility. Institutional investors take away liquidity.

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Its pretty much always a positive to have large institutional investors. Here's a few cases where I can see an argument against large institutional investors:

  • In recent years, we've seen corporate raiders and institutional investors that tend to influence management in ways that are focused on short term gain. They'll often go for board seats and disrupt the existing management team. It can serve as a distraction and really hurt morale.

  • Institutional investors also have rules in their prospectus that they are required to abide by. For example, some institutional investors will not hold on to stock below $5. This really affected major banking stocks, some of which ended up doing reverse stock splits to keep their share price high.

  • Institutional investors will also setup specific funds that require a stock to be listed as part of an index (i.e. the SPY, DJIA etc.,). When a stock is removed from an index, big investors leave quickly and the share price suffers.

  • In recent months, companies like Apple have made their share price more affordable to attract retail investors. It gives an opportunity for retail to feel even more connected to the company. I'm not sure how much this affects overall sales...

  • Generally, a good stock should be able to attract both retail and institutional investors. If there's not a good mix, then its usually a sign that somethings amiss.

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Because someone smarter than you by 50 IQ points (a quant) will depart their larger position long before you have a chance to see it coming. Your stop losses are useless as the market will open with the issue below your sell price. Your trade even if place at the same mine would settle after theirs. don't piss in the tall grass with the big dogs. If they are wrong or right does not matter you will be haircut or whipsawed.

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Let’s turn this round.

  • If a lot of customers of a company think the company is so good they should own part of it, is this good or bad….
  • If a lot of employees of a company think the company is so good they should own part of it, is this good or bad….
  • If the founders (and their descendants) of a company think the company is so good they should own part of it, is this good or bad….

Now what if the only people willing to own part of company are doing it due to the expectation that they will make money in the short term form the company….

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Generally speaking, having more institutional investors is a good sign.

  • Institutional investors are more likely to be activists, which means they will throw out bad managers and vote against decisions that steal money from equity holders in order to benefit company insiders (think unnecessary corporate jets, unprofitable vanity projects, and unreasonably high CEO compensation). There is good evidence in the finance literature that institutional holdings improve corporate governance.
  • Institutional investors are more likely and able to do research, so their ownership may be taken as a good sign.
  • Institutional investors are often prohibited from buying very risky securities so again ownership may be a good sign.

Of course there are many types of institutions. Normally we are thinking of mutual funds, pension funds, endowments, and hedge funds. They may not all have the same implications. Hedge funds, in particular, are out to make a buck with very little restriction on how they do it. They may buy an undervalued stock and then use their voting power to improve the company or they may do something more questionable, like pump up the stock price and then sell at the high, causing volatility. The people you are referring to may be thinking of something like the latter. Those concerns are generally small when compared with the known positives of institutional ownership.

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