What it is:
An institutional investor is an organization, rather than an individual, that invests on behalf of the organization's members.
How it works (Example):
Institutional investors are the biggest component of the so-called "smart money" group. There are generally six types of institutional investors: pension funds, endowment funds, insurance companies, commercial banks, mutual funds and hedge funds.
Most institutional investors in the U.S. are regulated by the Securities and Exchange Commission (SEC). Institutional investors must file a Form 13F with the SEC to report their quarterly holdings; they must also file a Form 13G if they own more than 5% of a company's stock. Retail investors can use these public filings to peek into what institutions are buying or selling each quarter.
Institutional investors have the resources to do extensive research on wide-ranging investment options, and due to their specialized knowledge, they generally have an edge over retail investors. Portfolio managers often meet personally with company executives, study entire industries, and evaluate companies in depth before making specific investment decisions.
Why it Matters:
First, institutions are usually the largest force behind supply and demand in securities markets, thus they have a major influence of the prices of many securities. The vast majority of the trading on major exchanges is done by institutions and it's important to note that because of the size of their portfolios, institutional buying and selling may greatly influence the price of a security.
Second, because they're considered to be the "smart money" in the market, an institution's buy/sell activity can be of great interest to individual investors. In particular, SEC Form 13F can act as a window into secretive firms' portfolios. Institutional ownership of specific securities can be found on many financial websites or in Investor's Business Daily. The investor relations departments of public companies often disclose who their institutional shareholders are as well.