Ask Gabby: What are fractional shares and why is everyone talking about them?

Q: What are fractional shares and why is everyone talking about them?

A: Fractional shares are when you, quite literally, buy a part of a share in a company or a listed investment (like an ETF or an investment trust), rather than buying a whole share.

Fractional share dealing is a relatively new concept. Whilst fractional shares have existed in the past as a result of stock splits or other such corporate actions, in recent years more and more dealing platforms have been offering the option to buy fractional shares at the outset. This has made it much easier for investors with smaller portfolios to access stocks and other listed investments which they would not otherwise be able to buy.

For example, as at Monday 10th July, the share price for Astrazeneca is approximately £101 per share, the price for Alphabet Inc (Google) is around $119 (c£93) and the share price for the iShares NASDAQ 100 UCITS ETF is around $858 (c.£671).

For a relatively small investor who is looking to invest a few hundred pounds each month, it would be very difficult to achieve a well diversified portfolio if you could only buy whole-number shares in assets like these. As a result, fractional share dealing has become very popular with retail investors.

However, in recent weeks, it has come to light that the FCA and HMRC are reviewing fractional shares and their eligibility within ISAs.

As a reminder, an ISA, or Individual Savings Account, is a tax wrapper within which your savings or investments can grow free of income tax (on dividends, interest etc) and capital gains tax (on disposals). Because of the tax advantages, the amount you can pay into an ISA is capped each year. The current allowance for 2023/24 is £20,000.

There’s a lot of nuance to the rules and laws being reviewed here, but the crux of it is as follows:

• HMRC are arguing that the laws and rules regarding ISAs specify ‘shares’ as qualifying investments
• Tax laws only recognise full shares of a company or listed entity
• Fractional shares may therefore be un-qualifying ISA investments

If HMRC and the FCA continue down this route, leading them to effectively ban fractional shares from ISAs, it could result in thousands of investors being affected. It’s yet to be seen what the impact of this will be; platforms may be forced to sell ineligible holdings; investors may be liable for years’ worth of unpaid capital gains or income tax; and platforms and investors may be liable for HMRC penalties.

At this stage, speculating on what might happen isn’t the most constructive; the decision may never be made or might not be made for several months. What is more useful is to consider the alternatives to the investments in which fractional shares are purchased.

Direct stocks

There is, unfortunately, no substitute for buying direct stocks via fractional shares. An investor could switch to buying fewer stocks, giving up some diversification, in order to be able to only own whole-number shares. Alternatively, the investor may need to consider buying funds and collective investments instead.

At TILLIT, we think that funds are a great solution to provide both diversity and breadth of opportunity. When you buy an active fund, you’re buying that fund manager’s time and expertise. The fund manager will be reviewing the whole of the market in which they invest and may be considering both ideas and opportunities that a retail investor just doesn’t have the capacity, time or resource to find.

ETFs

ETFs, or Exchange Traded Funds, have become extremely popular in the last decade; many investors use them as a low cost route to market. ETFs are typically passive investment funds which aim to track a particular market or index for a very low cost. There is no active management to the fund, rather the strategy aims to replicate a given market or index.

The good news is that there are many passive funds which use an open-ended fund structure rather than an exchange-traded fund structure. This will mean that they continue to be eligible for ISAs if this FCA/HMRC ruling goes ahead. We have a number of passive open-ended funds available on TILLIT which you can view here.

Investment Trusts

Investment trusts are another listed investment vehicle which would be impacted if fractional shares are disallowed. Whilst investment trust management teams typically keep their share prices lower (for example, the share price for Scottish Mortgage Investment Trust is currently around £6.40), fractional dealing can still be useful for regular investors. Some investment trusts do have an open-ended fund alternative so it may be that an investor can switch from one to the other. If not, you may be able to find a similar fund with an open-ended structure.

Whilst we wait for a decision and an outcome from the FCA, investors should take comfort in knowing that there are thousands of funds available to them. Excluding ETFs and Investment Trusts from this pool may be frustrating, but it doesn’t mean that there are no opportunities left. At TILLIT, we believe that long-term value lies in funds; if you’re not sure where to start when it comes to narrowing your search, why not see how our experts can help.