Institutional investors are key actors in the financial markets of diverse developed economies. Their tendency toward diversification and risk-taking behavior is well documented, yet insufficient attention has been paid to the sources of this behavior. Based on the case of emerging financial markets in Israel, this paper argues that in adopting various neoliberal reforms, state agencies induced institutional investors to change their investment behavior toward diversification and greater risk-taking. Until the early 2000s, Israel’s institutional investors were marginal actors in a financial system designed to support state-building, primarily investing in government bonds and bank deposits. As changing state financial interests induced market changes, institutional investors emerged as autonomous actors, diversifying their investments to also include corporate bonds, stocks and investments in foreign financial markets. With individuals’ growing dependency on institutional investors for their financial security, greater insight into the role of state agencies in financial markets could help identify factors affecting their functioning in financial capitalism.