Key Players in the Private Market Ecosystem

Have you ever noticed how with most common consumer products, the more you buy, the cheaper it is?

Take common toiletries like toothpaste or shower gel, for instance. The smallest pack is always the most expensive on a per-unit basis. If a 100 ml bottle costs you Rs. 100, a 2 ltr bottle will probably only cost you Rs 1,200-1,500. In fact, if you’re ordering for a business, say a BnB or a hotel, you can get it for even cheaper!

It is only logical if you think about it. After all, the company can save on packaging and offload in bulk!

The investment markets work in the same way. Retail or individual investors certainly take the crown in the number of participants.

However, when it comes to the value of the investment or the ticket size, no one comes close to the institutional investors. And this is the reason why they have always been able to participate in the slightly lesser-known investment assets like the private markets.

In this chapter, we’re going to deep dive into institutional investors in the alternative investment space and discover the role they play.

Institutional investors are very important participants in the financial markets. Unlike individual investors, who generally invest their personal funds, institutional investors are non-individual entities that pool together money from various sources to invest in a range of financial instruments like stocks, bonds and alternative assets. Their role is not just limited to investment; they also play a crucial part in shaping market trends and contributing to economic growth.

Institutional investors come in various forms, each with its unique characteristics and investment goals. They include pension funds, insurance companies, mutual funds, endowment funds, hedge funds, investment banks and more. Each type has a distinct approach based on its underlying objectives and investment horizon.

In the Indian context, institutional investors can be broadly categorised into Foreign Portfolio Investors (FPIs) and Domestic Institutional Investors (DIIs).

• Foreign Portfolio Investors: FPIs, as the name suggests, include entities such as Foreign Institutional Investors (FIIs) and Qualified Foreign Investors (QFIs). Under SEBI’s regulations, these entities are merged into a single category known as FPIs. FPIs have been pivotal in liberalising foreign investment in Indian markets and have specific norms regarding investment limits and eligibility criteria.
• Domestic Institutional Investors: DIIs are institutional investors based in India, investing in Indian financial markets. They play a significant role in providing capital to businesses and adding liquidity to the securities they trade. DIIs include entities like Indian mutual funds, insurance companies, pension funds and others.

The evolution of institutional investors in the Indian equity markets has been marked by significant growth, especially in the involvement of Foreign Institutional Investors (FIIs).
The journey began in 1993, and a notable increase in FII activity was seen from 2003 onwards, driven by global liquidity and interest in emerging markets like India. This period saw increased global liquidity and a rising interest in emerging economies like India. The bull run in the Sensex beginning in 2003, which continued until the 2008 recession, was a significant phase of FII investment growth.

Post-recession, there was a temporary dip, but investments picked up again by mid-2009. The number of registered FIIs also showed substantial growth during this period, reflecting the increasing interest of foreign investors in the Indian equity market. The period from 2001 to 2010 also witnessed high debt flows into the currency bond markets, driven by low inflation and high global liquidity conditions.

In terms of numbers, the year 2003 marked a turning point with an average of 51 new FIIs entering the Indian market annually. By 2010, there were 1,741 registered FIIs, a stark contrast to the solitary FII in 1993.

The last decade in Indian equity markets has seen a dramatic evolution in the role and impact of institutional investors. From 2012 to 2021, India attracted approximately US$237 billion in private equity investment, showcasing its growing attractiveness as a global investment destination. The private equity and venture capital ecosystem in India has been particularly eventful during this period.

Despite the disruptions caused by the COVID-19 pandemic, the impact on the private equity and venture capital industry was short-lived. In fact, the first nine months of 2021 alone saw investments of US$49 billion across 840 deals, surpassing the total for 2020.

This period also witnessed significant investments in start-ups, with over US$100 billion flowing into this sector since 2010. The year 2021 was marked by major investments across various sectors, notably in consumer technology, IT/SaaS, BFSI, and healthcare, which attracted nearly 80% of the total investment inflow. The SaaS industry in India experienced explosive growth, and the country is now home to more than 10,000 SaaS startups, a significant increase from 3,000 in 2014.

The rise of Direct-to-Customer (D2C) companies has also been a notable trend, with the market for such services expected to reach US$100 billion by 2025. These startups, with their innovative approaches and efficient use of technology, have made significant inroads in the market.

Furthermore, the Indian equity market has continued to attract foreign institutional investors (FIIs). In 2023, FIIs poured US$16 billion into the Indian equity markets. This influx came after a period in 2022 when FIIs offloaded shares worth the same amount. The increase can be attributed to India’s stable government policies and robust macro fundamentals. The focus on digital acceleration and wider adoption in Tier-II and Tier-III cities is expected to guide further growth in the years ahead.

Institutional investors are integral to the private market ecosystem due to their ability to allocate large amounts of capital efficiently, their influence on corporate governance, and their contribution to market liquidity and stability.

1. Capital Allocation and Market Efficiency

   One of the primary roles of institutional investors in private markets is capital allocation. They channel large pools of capital into diverse investment opportunities, from startups to mature companies. By doing so, they help in the efficient distribution of capital across various sectors of the economy.

   For instance, pension funds and sovereign wealth funds often invest in private equity and venture capital funds, which in turn invest in a range of companies across different stages of growth. This capital infusion is vital for these companies, often leading to job creation, innovation, and economic growth.

2. Risk Appetite

   Institutional investors generally have broad investment portfolios and can absorb higher levels of risk compared to individual investors. This risk appetite allows them to invest in alternative asset classes like private equity, hedge funds, and real estate, which might be too risky for individual investors.

3. Influence on Corporate Governance and Strategy

   With substantial stakes in companies, institutional investors often have the power to influence managerial decisions. They can advocate for operational efficiencies and push for strategic initiatives that align with long-term value creation.

   Example: Institutional investors like BlackRock and Vanguard have been known to use their shareholder voting rights to influence corporate decisions, pushing for better environmental, social, and governance (ESG) practices.

4. Liquidity Provision in Private Markets

   Although private markets are typically less liquid than public markets, institutional investors can enhance liquidity through their significant investments and exits.

   When institutional investors decide to invest or divest, it can have a considerable impact on the market, creating opportunities for other investors. Their exit from investments often leads to secondary market opportunities, where other investors can buy into previously held institutional investments, thus enhancing the liquidity of the private market.