Fractional Shares: The End Of ETFs And Beginning Of Owner Engagement?

Fractional Shares Have The Ability To Make ETFs Obsolete, Directly Connect Companies To Shareholders, Provide Transparency And Enable Customization

An often overlooked attribute of robo-advisor digital experiences has the potential to revolutionize how investors engage with their wealth, extract better outcomes and build relationships with the firms they own stock in.

How We Got Here

For hundreds of years, investors wanting to own portions of corporations have been able to purchase shares in specific, publicly traded firms. The cost of these shares was kept largely within the reasonable purchasing ability of an average U.S. investor with a stock splitting into smaller pieces when it became prohibitively expensive.

Then, about 50 years ago, investors were able to purchase much larger exposures to companies through pooled investment vehicles we now know as mutual funds. While many still had investment minimums, investors were able to gain access to thousands of companies without spending millions of dollars and things were great!

However, the world changed again in the early 2000s as self-directed, web-based trading platforms popularized fractional access to the same securities. Followed shortly by the robo-advisor trend, fractional shares delivered a more planful and user-friendly overlay and helped investors move quickly and cost-effectively into ETF and mutual funds.

We’re now starting to see a possible third wave: Fractional shares may become a way to significantly enhance portfolio customization in more traditional portfolio/client/advisor relationships and could spell the end of the mutual fund/ETF.

Fractions To The Rescue

While mutual funds and ETFs are largely efficient ways for smaller investors to gain access to investment themes, they have some serious drawbacks: Mutual funds and ETFs charge an investment fee for their services which is extracted from the underlying assets in a way that masks the real cost of the investment.

Investors looking to avoid owning portions of firms that do not align with their values are largely at a disadvantage also, as the pooled nature of the fund make transparency and control of the underlying investments nearly impossible for an investor to see. In addition, investors in funds lack the tax benefit of actively netting loss-generating transactions against realized gains in the portfolio. In short: they’re inefficient and investors are right to expect more.

ETFs are inefficient

In contrast, modern fractional-share custodian platforms coupled with zero-cost transaction fee schedules and modern UMA (strategies published for other firms to follow the recipe and trade on their own platforms) can largely replace what the fund or ETF do for investors and can lower the cost of that investment significantly.

In addition, they allow the advisor and client to tailor and customize the portfolio in innumerable ways: ESG investing, customizing specific company profiles, managing around external assets or client over-exposures (for example, that investor’s corporate ESOP or profits interest/options plans) and more.

Fractions Connect Companies & Investors

With mutual funds and ETFs, the connection between investors and their corporate investment is murky. They only know the name of the fund company and not much beyond that. That lack of connection, especially in our current world of brand affinity and demands for customization, represents an additional (and possibly even more revolutionary) impact of fractional ownership: It can allow a company to connect with its investors in the same way they connect with their consumers.

Would you like some shares with that?

In our re-imagined world, investors in Starbucks are connected to their mobile app and get a free extra shot of espresso with a “Thanks for being a shareholder!” at the register. Investors in Home Depot are sent notifications about their expansion plans in your state and you’re asked about the types of products you might buy and whether you’d be willing to share insights with regional leaders via a regional investor’s roundtable. Nike offers shares in their firm with each purchase of shoes.

With fractional shares, companies can drive affinity, brand loyalty and an additional source of client engagement. The potential for this engagement to change purchase habits by activating the sentiment of being part of an “ownership” structure can seriously transform how investors engage with their investments.

Doug Fritz is Co-Founder and CEO of wealthtech strategy consultant F2 Strategy.

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