Institutional vs. individual investors

A remarkable transition has taken place in the stock market over the last several years: Individual investors have become a force, particularly in technology stocks.

3 min read
A remarkable transition has taken place in the stock market over the last several years: Individual investors have become a force, particularly in technology stocks.

Fueled by rapid growth in Internet adoption, the easy availability of news and financial data, and substantial decreases in the cost of trade execution, individual investors are taking greater control over their assets and investing directly in specific stocks.

As proof of this, cash flow into mutual funds has been steadily declining, while the number of online accounts has soared to more than 9 million. Online trades account for around 20 percent of total equity trades. In the Internet sector in particular, much of the tradable float is in the hands of individual investors.

This is a key concern for CEOs who aspire to take their companies public or whose companies already are public, since individual investors and institutions value stocks differently.

The lure of Internet stocks to individual investors is clear. Investment returns in this sector over the last few years have been extraordinary, dramatically surpassing returns in most other sectors. In addition, following a lesson from the Peter Lynch school of investing, many of the same people who invest in Internet companies' stocks are users of the Net firms' Web sites. They buy what they know.

It used to be that having a high percentage of a company's stock in the hands of individual investors was not seen as a positive. Individual investors were not long-term investors, flipping out of stocks quickly and increasing stock volatility. In the Internet economy, however, individual investors have become a significant and untapped asset for companies.

Despite all of the media attention devoted to day traders, most individual investors hold on to stock substantially longer than institutional investors. Seventy-nine percent of E*Trade investors still own stock six months after they buy it.

As with many sudden changes, several components of the investment banking process have not kept pace with the changes in the brokerage business.

Individual investors do not have access to IPOs commensurate with their ultimate ownership in technology stocks. Typically, 85 percent or more of IPO stock is placed with institutional investors, which value stocks differently.

Deals that are priced to reflect only the institutional demand curve are often underpriced, and the company leaves money on the table. Individual investors often do not have access to high-quality research to help them make more informed investment decisions. Analysts at traditional investment banks focus on institutions, leaving companies without a channel of communication to individual investors who may own the majority of their stock.

The investment banking and research process is set up to serve institutional investors, which have become far less meaningful in the Internet arena. For some time, individual investors have driven Internet stocks.

Although institutional investors are still important, there is a movement to better serve companies and individual investors. Several new Internet-based banks, including E*Offering (my employer), Wit Capital, and WR Hambrecht, each with somewhat different solutions, have emerged to target this opportunity. By opening IPOs and providing high-quality research to individuals, companies are likely to leave less money on the table. They also can use fund-raising events to boost their businesses by turning customers into investors and vice versa.

The long-cloistered investment banking world is not immune to the effects of the Internet. The innovations emerging from Internet-based investment banks and, more slowly, from traditional banks are helping to democratize the process, bringing greater value to companies and individual investors.