What it means
Many managers offer the same investment strategy in several share classes, which are versions of one fund with different fees and minimums. The institutional share class is aimed at big buyers who invest millions at a time.
Because the manager gains a large, stable client at low servicing cost, it can charge a lower percentage fee. Minimum investments typically start in the hundreds of thousands or millions of dollars.
Institutional investors often have professional staff who select funds, so these funds may have less marketing and fewer retail services such as call centres. Reporting is usually more detailed, covering things like holdings, risk measures and performance against a benchmark.
Fees are the main practical difference. A fund's expense ratio is the annual cost of running it, expressed as a percentage of assets, and it comes straight out of returns.
Over many years a difference of half a percentage point can add up to a large sum, which is why institutions negotiate hard. The term can also describe the nature of the investors rather than the fee structure.
Such funds may be used for pooled arrangements, for example commingled funds for pension plans, where assets from many schemes are combined to save cost. A nuance is that lower fees do not guarantee better performance.
Institutional investors still need to assess the manager's track record, strategy and risk, since a cheap fund that underperforms is no bargain. Some institutional funds use a different structure rather than just a cheaper share class.
A separate account lets one large investor have its own portfolio managed to its own rules, and a collective investment trust pools money from retirement plans in a way that avoids some of the costs of a mutual fund. These structures suit large investors that want more control or lower administration costs.
In practice
Real-world examples.
Example
A university endowment places $20,000,000 in the institutional class of an equity fund. Because of its size, it pays a much lower annual fee than an individual saver buying the same strategy through a bank.
Example
A manufacturing company invests surplus cash in an institutional money market fund. The minimum investment is $1,000,000, and the lower fee means more of the interest earned stays with the company.
Example
An insurer uses an institutional bond fund to gain exposure to corporate debt. The fund provides detailed monthly reporting on credit quality, which the insurer needs for its regulatory returns. The insurer also negotiates a lower fee tier as its holding grows, since many managers cut fees as assets increase. The treasurer reviews the interest earned against a money market benchmark each month, to confirm the fund is delivering what it should.
Formula
Calculation
Annual fee saving = Assets invested x (Retail expense ratio - Institutional expense ratio)
A company pension scheme has $5,000,000 to invest. The retail share class of a fund charges 0.90% a year, while the institutional share class charges 0.35%. The difference is 0.90% - 0.35% = 0.55%.
Annual fee saving = 5,000,000 x 0.0055 = $27,500
The retail class would cost 5,000,000 x 0.009 = $45,000 a year, against 5,000,000 x 0.0035 = $17,500 for the institutional class, and 45,000 - 17,500 confirms the $27,500 saving.Case study
Seen in the real world.
Oakhaven Pension Scheme is an illustrative, fictional scheme with $40 million in assets, which was invested through retail share classes picked years earlier by a previous administrator. The new finance director reviewed the fee schedule.
Moving to institutional share classes of the same funds reduced the average expense ratio from 0.80% to 0.40%. The annual saving was 40,000,000 x 0.004 = $160,000, with no change to the investment strategies at all.
In this illustrative story the trustees were pleased, but the director also reminded them that the saving only mattered if the manager's performance held up. The scheme kept a yearly review of results against benchmarks. The trustees asked the director to repeat the fee comparison every two years, since fund fees tend to change as managers compete for large clients. The change also freed up time at trustee meetings, which had previously been spent debating which funds to hold rather than whether performance justified the fee.
Watch out
Common mistakes.
- Assuming an institutional fund is a different strategy, when it is often the same portfolio in a cheaper share class.
- Choosing a fund on low fees alone, without considering performance, risk and the manager's process.
- Overlooking the minimum investment, which can exclude smaller investors from the cheaper class.
Questions
People also ask.
Who can invest in an institutional fund?
Typically pension schemes, insurers, endowments, foundations, corporations and wealthy investors who meet the minimum investment.
Why are fees lower for institutions?
Large investments reduce the manager's cost per dollar of assets, and institutional buyers have the bargaining power to negotiate.
Can an individual ever access these funds?
Sometimes, through an employer pension plan that pools many employees' money and invests in the institutional class.
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