Fractional share fix remains elusive for smaller investors

Calls for the introduction of fractional share trading have grown in tandem with the rise of model portfolios on platforms.

The inability to trade small portions of exchange-traded funds (ETFs) or investment trusts often means smaller clients hold products in different proportions to larger clients with the same risk profile. In many cases, it means model portfolios do not hold the products at all.

The Tax Incentivised Savings Association (Tisa) trade body launched a working group last August to address the issue, but has been confronted with legal and operational problems.

It is understood Tisa has accepted it may have to prioritise work on a particular product, likely ETFs, and then hope that similar solutions emerge for investment trusts and shares.

As the trade body acknowledged at the launch of its study, the introduction of fractional share trading would likely require a change in the law. But the length of time this process would take means it is now thought to be considering work-around solutions.

Discretionary managers, meanwhile, are continuing to adjust their investment strategies until a solution is found.

Jonathan Webster-Smith, head of MPS at Brooks Macdonald, said: “When we go onto a platform, we don’t buy ETFs because we would have the rounding issue.

“We have ETFs and we have to replace them on platforms so we can’t mirror what we do [elsewhere]. If we think it’s the right investment we should be able to put that on platforms. This has an impact on model portfolios, which are growing and [are] a bigger part of the market.”

Although fractional dealing in Oeics is permitted, most ETFs are not eligible because they are domiciled in Ireland.

The Tisa group is thought to now be exploring the feasibility of fractional dealing in Irish structures, which may mean changes to European law. Only then will it be able to gauge whether registrars could cope with the proposed changes.

Lynn Hutchinson, an ETF specialist for Charles Stanley, said she did not expect developments in the near future.

“It has come on the radar a few times over the past few years, but platforms are slow to do anything with their infrastructure,” she said. “This will take them a while to sort out.”

Some wealth managers have workaround processes in place, and Nutmeg launched fractional dealing last month.

But a scaleable solution, able to be used by wealth and discretionary firms of all sizes, remains the goal for all parties.

Guy Foster, head of research at Brewin Dolphin, said: “Introducing fractional dealing would expand the range of potential investments for clients. Optically at least, you would get a lower cost from ETFs.”

However, he added other problems with fractional dealing – such as if an investor with a fractional holding decided to liquidate – needed to be addressed.

‘Cash balance’ an issue for model portfolios

Model portfolios are an increasingly popular way of accommodating smaller-value clients, but the inability to trade fractions of shares is a problem.

In effect, the issue means there is frequently a “cash balance” left over when allocating an ETF or investment trust purchase to a smaller client’s portfolio.

A client with £100 to allocate, for example, wanting to buy an ETF or other single share costing £15, would only be able to receive six shares, leaving £10 spare.

This balance is often temporarily allocated to a ‘rounding client’, but here further problems arise in terms of settlement. In practice, some wealth managers simply avoid holding the likes of ETFs in their models (see main text).