Your Money: Fractional investing benefits small investors

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By P Saravanan

The concept of fractional investing will soon become a reality in India. The ministry of corporate affairs has formed the Company Law Committee which recommended the issuance of fractional shares. The framework for fractional shares investing is expected soon. As per the current norms, investors need to buy at least one share of a company whereas the fractional shares system allows one to put in a fixed sum of money to buy a particular stock.

What is a fractional share?

Let us assume that one share of company ABC is currently trading at Es 68,000 which may not be affordable for all. Under fractional investing, an investor could invest a partial amount, say Rs 100 or Rs 500, to buy a percentage of ABC company’s shares which might be affordable for the investor. When. investors buy a fractional share, they possess the ownership as well as the risk of loss like an investor with a full unit of share. Also, the investor will receive dividends based on the percentage of shares owned.

Why fractional investing?

Another interesting aspect related to investing in fractional shares is that it will open up a new arena for retail investors who till date have concentrated on exchange-traded funds and mutual funds. Once introduced, retail investors will now have an opportunity to invest in good companies which were earlier not affordable owing to the high price. This will help them to build a diversified portfolio which, in turn, will reduce the overall portfolio risks. With fractional shares, this diversification comes at a much lower acquisition cost. This does not necessarily mean that fractional shares are free from risks. But, it lowers the acquisition cost for the investors.

The US vs Indian context

The concept of fractional investing originated in the United States of America (USA). However, its operationalisation in the Indian context must be different. In the USA, the brokers act as the agents/brokers as well as the dealers/principal, and hence they have more flexibility compared to the broking houses in India. For instance, the stockbrokers in the US have the ownership of the shares either in the name of the investor or under the street name (which is under the broking firms/dealers’ name).

Hence, sometimes they purchase a specific high-value share and then divide it into fractions which are then transferred to the investors based on their contribution. Even though the owner is mostly under the agent’s/broker’s name, the ownership of fractional shares in the investor’s name is maintained by the agents/brokers in their ledgers. So, in the USA, fractional shares are often offered by brokers. This working flexibility of the brokers increases the risks as well as the profits associated with investing.

While in India, the system works differently, wherein for trading in the stock markets, one has to open two different accounts; namely, Demat and trading accounts.

The purchases made by investors in the form of shares and bonds are held in the demat accounts which are maintained by the independent depositories such as NSDL and CSDL and the ownership is strictly under the investor’s name. But, the trading account is the window through which orders are placed. In the US, there is no concept of demat account and hence the brokers have the shares mostly in the street name and assign investors as the beneficiaries in their ledgers. But, the brokers in India have certain restrictions and regulations regarding the ownership of the shares which gives the investors an extra layer of protection.

So as of now, the modus operandi related to investing in fractional shares is not clear and it requires a clear set of guidelines from the government. We hope it will open up new avenues for the investor community as well as the economy as a whole. Hence, the investors should keep a close eye on the framework and guidelines that will be put forward by the authorities related to fractional shares.

The writer is a professor of finance & accounting at IIM Tiruchirappalli. With inputs from A.Paul Williams, research staff at IIM Tiruchirappalli.