Institutional investors (and among these, investment funds) play a key role in financial markets' development. They represent the world's largest source of equity capital, contribute to both efficiency and modernization of the allocative mechanisms of a financial system, and may foster an improvement in corporate governance practices by monitoring firm management. According to the OECD, at the end of 2015 investment funds' assets under management represented about 104% of GDP in the US (up from nearly 72% in 2008). They stood at around 56% in Germany, 71% in France, and 17% in Italy. Given the size and the role of institutional investors, understanding the drivers of asset managers' allocation decisions, and in particular of equity allocation in listed firms, is fundamental on economic and financial policy grounds.
Consob Working paper n. 86 (available here) sheds some light on this issue by analyzing the determinants of institutional investors' equity holdings in the major 100 non-financial companies listed in France, Germany, Italy, Spain and the UK between 2010-2015. The analysis focuses on the end-of-year aggregate stakes held by three categories of active institutional investors (ie, mutual funds, sovereign funds and hedge funds) in each of the 500 listed firms in the sample.
Institutional shareholdings in main European firms
Over the period under analysis, institutional investors' holdings represent on average about 26% of shareholders' equity, with mutual funds accounting for the largest category among all active investors (indeed they hold nearly 20.5% of equity), followed by sovereign and hedge funds.
Over time, institutional ownership has remained fairly stable in Italy and France, while rising in Spain, the UK, and to a lesser extent in Germany. Institutional ownership varies a lot across countries, from an average of 13.5% in Italy to nearly 50% in the UK, mirroring well-known differences across European countries.
In order to ascertain the extent to which institutional holdings are driven by differences across economic and financial systems, it is interesting to review divergences across the surveyed jurisdictions both at the country-level and the firm-level.
The determinants of institutional shareholdings: country-level factors
Over the period of 2010-2015, the GDP of sample countries grew at a different pace, with Italy and Spain recording the lowest values (-0.3% and -0.1%, respectively), and Germany and the UK recording the highest figure (+2%). Country risk, as proxied by public debt over GDP, ranges from a minimum of 60.1% in Germany to a maximum of 133% in Italy. Jurisdictions show a striking variability also along some indicators proxying the quality of both the legal and the judiciary systems. The insolvency recovery rate is about 57% in France, rising to 62% in Italy and reaching about 89% in the UK, whereas the time for judicial enforcement of a contracts is recorded as being the worst in Italy, with 1,183 days, and France being the best, with 393 days.
All these macro variables may play a key role in the attractiveness of a country to institutional investors. Indeed, our findings (resulting from the estimation of a standard fixed-effect model and corroborated by a fractional regression model) confirm that institutional investors as a whole prefer companies operating in countries with higher GDP growth, declining debt-to-GDP ratio and more efficient legal systems.
The determinants of institutional shareholdings: firm-level factors
As for micro variables, potentially relevant to institutional investments, the literature documents institutional preference for liquid assets. Therefore, it is interesting to evaluate the impact of firm's market capitalization and free float. Again, the European firms in our sample show a significant variability across these dimensions, with the average market capitalization of the 100 largest Italian companies equalling about 2.9 billion euros, lower than the Spanish figure (3.5 billion euros), and about 6.5 times smaller than that of an average British company (18.3 billion euros). German and French firms record respectively an average market value of about 10 and almost 12 billion euros. Our findings confirm that institutional equity stakes are positively associated to stock liquidity.
Free float is correlated with the share of the largest shareholder, which is included in the econometric specifications also as a proxy for the degree of corporate control contestability. In principle, the degree of contestability should be positively associated with institutional investors' propensity to invest in a company, as higher contestability should imply higher market discipline and lower chances of managerial opportunistic behavior. On average, the sample stake of the first shareholder is nearly 29%, with the UK recording the lowest value (9.7%) and Italy achieving the highest figure (almost 46%). Depending on the empirical specification, the paper shows that the share of the first shareholder is statistically significant and has the expected impact (ie, the lower the stake of the largest shareholder, the higher institutional holdings).
We also test the impact of firms' financial characteristics (eg, profitability and leverage). Among firm-level variables accounting for profitability, we included return on equity (ROE) and sales growth. Over the sample period, return on equity was on average relatively high (9.2%), sustained by a consistent sales growth (at nearly 6%). As for the indicators of financial resilience, leverage (ie, corporate debt relative to equity) was higher for Spanish companies (6.2), followed by Italian firms (at 4.3), while German, French and UK companies displayed lower values (respectively, 3.1, 3.6 and 3.9). As expected, the results confirm the institutional preference for more highly profitable and less leveraged firms.
Finally, the analysis focuses on the impact of firms' corporate governance, by including several indicators such as board size, CEO duality (ie, the CEO acting also as chairman), board members' attendance rate, the percentage of independent directors on the board, the presence of compensation and nomination committees and the percentage of independent directors sitting on board committees. Depending on the empirical specification, some of these indicators turn out to be significant, thus suggesting that large boards and CEO duality are not appreciated by institutional investors, while the presence of a nomination committee is valued: in general firms scoring well in corporate governance quality are preferred. The interpretation of these results, however, requires a certain degree of caution since they might mirror a reverse causality relationship, with the presence of active institutional investors fostering good corporate governance practices rather than the other way round.
To sum up, our findings point out that both macro and company-level variables play a significant role in institutional investors' decisions. On policy grounds, these results imply, among the other things, that raising the efficiency of the legal and judiciary systems as well as of the quality of corporate governance may make financial markets more attractive to institutional investors.
Francesco Fancello is Economist and Nadia Linciano is Head of Economic Research Unit at the Commissione Nazionale per le Società e la Borsa (CONSOB). The opinions expressed in this post are the authors'personal views and are in no way binding on Consob.