Explaining fractional shares of ETFs

In the United States, stocks and ETF units can now be purchased in fractions.

Investors can buy a fraction of a share or an ETF unit from certain U.S. dealers, allowing them to invest an exact amount rather than purchasing a number of units roughly equal to their budget.

Since 2019, this feature has been offered in various forms by online financial services companies including Stockpile, M1 Finance, Betterment, Stash Financial and Robinhood Markets.

Since January, industry giant Fidelity Investments has been offering a service to U.S. investors through its online brokerage platform that allows fractional share and ETF trades free of charge, in real time.

An investor with $20,000 to invest who wants to buy a stock or ETF that trades for $130 would normally have to buy 153 shares for $19,890, Fidelity’s website explains. But fractional shares would allow them to buy 153.8 shares for the full $20,000.

“[You] don’t need to do the math to determine how many shares you can buy with the money you have after taking into account the stock price and trading costs,” the explanation says.

A Fidelity spokesperson was not available for an interview.

In the U.S., demand for fractional ETF trading has been high because ETF unit prices are higher than in Canada, says Daniel Straus, vice-president and head of ETF research and strategy at National Bank Financial.

Most ETFs replicating the S&P 500 cost US$200 or more per unit, Straus says. That’s because bid-ask spreads and trading commissions cost less if the unit price is higher, and these ETFs are used by institutional investors who trade with millions of dollars at a time and want to minimize transaction costs.

In Canada, most ETFs are priced at $10 or $20, specifically to provide self‑directed investors and investment advisors with more accurate pricing, even for small accounts, Straus says.

Improved market access

Fractional or dollar-based trading means that the investor requires less capital to invest in companies or funds that would otherwise be inaccessible due to high share or unit valuations, facilitating portfolio diversification. For this reason, fractional shares or units are suitable for beginners or small accounts, Straus says.

In contrast, investors looking to invest $10,000 in a portfolio with precise allocations to Canadian, U.S. and international equities, emerging markets, Treasury bills and corporate bonds may have difficulty targeting precise percentages in their asset allocation plan, especially if the ETFs cost a few hundred dollars each. In addition, excess uninvested cash could account for a larger portion of their total balance, explains Straus.

For high-net-worth investors seeking to “fully invest” in a variety of equities or bonds at a set price per unit, excess cash will represent a very small percentage of their overall portfolio. Their concern will be keeping transaction costs down, says Straus.

“Even mid‑sized or larger investors may find fractional share and ETF trading convenient if they regularly deposit or withdraw small amounts from their portfolios, for example in a share purchase program that invests a small fraction of their payroll in the market,” he says.

However, investors have to factor in program costs, he warns: “Investing in fractional shares is not worthwhile if the associated costs outweigh the benefit of having a few hundred extra dollars invested.”

Fractional share purchase programs work by introducing an intermediary trust between the investor and the brokerage firm where the unit shares are held, says Straus. The “remaining” cash from several investors is pooled in a trust. The intermediate fractional share trust then allocates fractional ownership to trust participants.

“The problem is that this logistical task is not cost‑free. There may be a few basis points of additional fees charged to investors that could overwhelm the small cost of losing cash over time, especially for small amounts,” Straus says.

Raymond Kerzérho, director of research at PWL Capital, also believes that fractional units can be advantageous for smaller investors. For those with more substantial portfolios —$25,000 or more — the amounts left after buying whole units won’t be large in percentage terms, he explains.

Investors averse to having cash in their portfolio can hold a position in a low-fee index fund to use up uninvested cash, he adds.

Little impact on the industry

Access to companies with very high valuations is probably the main reason certain U.S. investors are keen on fractional shares and ETFs, says Alain Desbiens, director, BMO ETFs at BMO Global Asset Management.

“A person who wants to buy into companies like Apple, Netflix, Alphabet, Amazon and Berkshire Hathaway has to invest several thousand dollars,” he says.

However, Desbiens believes fractional shares, while attractive in many ways, are not for everyone. He equates this “innovation” more to an application developed by trading platforms to facilitate the trading experience.

“It wasn’t Fidelity, as a mutual fund or ETF producer, that launched this. It was its discount brokerage arm,” Desbiens says.

For this reason, he believes such an offering, if launched in Canada, would be primarily introduced through discount brokers and have little impact on ETFs.

“Investment for us is about discipline, research and innovation. We’re talking long-term rather than day trading,” says Desbiens.

Portfolio ETFs are a nice approach developed for small accounts looking for diversification, says Desbiens. He also highlights BMO’s launch in 2017 of accumulation units, an ETF structure whereby annual distributions are reinvested and consolidated in ETF units to increase net asset value.

Accumulation units are not to be confused with traditional dividend reinvestment plans (DRIPs), which allow distributions to be received in the form of new units. In comparison, accumulation units are designed to keep the number of units held constant. Reinvestment occurs through a higher unit price.

Accumulation units can be used by advisors seeking, for example, to avoid the routine task of reinvesting distributions from a bond ETF, says Desbiens.

This article was originally published in Finance et Investissement. Read the original French version here.