Explained: What are fractional shares and why are they useful in the Indian context?
Authored by Shlok Srivastav, Co-founder and COO of Appreciate
Warren Buffet’s Berkshire Hathaway currently trades at USD 547,625 (₹4,56,34,275) for one share. But you don’t need to buy a whole share to plug into its growth, thanks to fractional investing.
Fractional investing has been a standard feature of equity markets like the US. Indian equities are yet to catch up. But that may change soon. Investors will likely be able to access high-ticket-size stocks like MRF Ltd, Honeywell Automation India, Page Industries Ltd and others at a fraction of their prices in the near future.
What are fractional shares?
Traditional investing often involves purchasing whole shares of a company's stock. The significance of these shares is that the investor gets a stake in a company through the shareholder status. Shareholders also become entitled to the company's annual profits distributed as dividends.
The concept of fractional shares allows investors to own a portion of a share instead of whole shares. Typically, when companies undergo mergers and announce bonus issues or stock splits, investors can hold fractional shares. The conventional practice allowed investors to buy fractional shares only in case of a stock split or through a broker. Today, in the dynamic world of tech-led finance, many brokerage firms have enabled investors to invest in fractional shares at almost 0-brokerage.
While the concept is commonplace in the US, India is on its way to follow suit. Enabling retail investors to purchase fractions could allow more Indians to participate in the stock market.
So, let's understand the power and practicality of fractional shares and why they are becoming increasingly valuable for the Indian investment landscape.
A quick snapshot of the US market
In the US, a broker can also act as a dealer, i.e. a principal. Commonly known as broker-dealers, they have flexibility regarding where and how they execute orders. And since the US system of holding shares does not require the investor to have a demat account, the purchase of claims can be stored in either the investor's or the broker-dealer's name.
Therefore, from the perspective of enabling ownership of fractional shares, these broker-dealers own stocks in their name and allot fractional units to their clients. This is done by creating book entries for the fractional part(s) assigned by the broker-dealer to be owned by each client.
So, if Stock A is at a market price of USD 2,000 per share, the broker-dealer will purchase the whole stock at USD 2,000 and allow its clients to purchase fractions of the stock for lower amounts. So, if the broker-dealer has four clients with orders of USD 500, USD 100, USD 450 & USD 200, respectively, each client would have a separate ledger entry reflecting the purchase. The remaining inventory of USD 750 would be reflected under the broker-dealer's name.
The concept of fractional shares has been prevalent in the US markets and is enabled by many online brokerage platforms today.
Where India stands
In India, brokers are solely the agents of their clients. Since they cannot act as a principal, they cannot enable fractional investing. All orders collected by the brokers are sent, matched, and executed on stock exchanges (BSE, NSE). Executed orders of shares are held in the name of the clients (not the broker-dealer, like in the US) in a demat account.
Extensive regulatory changes are at the crux of enabling the purchase and sale of fractional shares in India. However, recently, the Ministry of Corporate Affairs and the Securities and Exchange Board of India (SEBI), the capital markets regulator, have expressed favourable interest in allowing the issuance of fractional shares by certain companies.
With increased interest in retail investment, SEBI's nod on fractional shares may lift retail participation in high-value stocks while diversifying company ownership. Where the US is at 55 per cent, India stands at a mere 3 per cent of the country's population that invests in the stock market.
The green signal on allowing fractional shares could entice new investors to invest in the markets and make expensive stocks more affordable.
Let's look at a few benefits of fractional shares
Fractional shares help companies diversify ownership to a greater degree by allowing retail investors to buy a slice of their pie. Building a diversified portfolio through fractional shares also reduces the risk of investing large sums of money towards just a few companies
Fractional shares enhance retail investors' access to high-value shares. It allows novice investors to enter the market and benefit from compounding returns sooner. While India is still evaluating the rollout of fractional shares, Indian investors can leverage this option by investing in the US markets.
Investors can still benefit from proportional dividend returns on their fractional shares. Based on how many shares an investor owns, they earn a dividend on that portion of the stock's dividend.
Fractional shares are not just a financial innovation; they represent a paradigm shift in the way Indians can engage with the stock market. In conclusion, as the financial markets continue to evolve, fractional shares stand at the forefront of a more inclusive and accessible era in Indian investing.
Disclaimer: Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Before purchasing fractional shares, understand your brokerage's fractional share policies and fully understand the pros and cons of buying portions of shares.