Points to Ponder. Fractions Come to Market

Recently I was checking the prices of shares of some of the iconic companies in the US stock exchanges. Amazon Inc was going at $ 3500 while Alphabet (Google’s parent) was at $ 2450, which in rupee terms would be over 1.8 lacs. And if you wanted a share of Berkshire Hathaway, it would cost you a whopping Rs 3 crores!

With capital flows getting increasingly globalized and with India accounting for merely 3 per cent of global market capitalization, increasing number of investors are seeking diversification through direct investment in well-known global companies. But then the average Indian investor is confronted by prices which make it difficult to have a diversified portfolio of US equities that hold out promise of credible growth story. So, It seems, financial innovation has taken a leaf out of yester year poet Julia Carney who presciently observed that “little drops of water, little grains of sand, make the mighty ocean and pleasant land”, by enabling investors to build a portfolio of marquee shares by buying small portions of them. Today investment platforms enable Indian investors to transact in fractional shares of US companies (As of now, Indian stocks can’t be bought/sold in fractions). Instead of buying one share of Amazon at about Rs 2.6 lacs, investors can buy 0.1 share of the company. With fractional shares, however, one does not get voting rights but dividends are distributed proportionately. Most stocks worth over $1/share with market capitalization of over 25 million are eligible for fractional orders. While fractional shares are well regulated, trading in them comes with certain limitations. For instance, the price of the fraction may not be in proportion to the whole, as supply and demand would dictate the price of the fractional. Also the time required to buy a fractional can be more than regular shares due settlement issues. What is of greater concern is that US brokers can, at their discretion remove any stock from the list of stocks eligible for fractional trading. In such fractionals no new positions can be taken and the broker will close existing positions in stocks not eligible for fractional trading. Further, if you want shift from one broker to another, your fractional holdings will be sold and you will receive the sale proceeds which could entail tax obligations and other fees. Resident Indians can fund such overseas purchase of shares to the extent of $ 250000/- in a financial year under RBI’s LRS (Liberalized Remittance Scheme).

Fractional investing is not confined to US stocks alone. Tech powered fractional investing platforms are mushrooming in the commercial property space as well. Platforms such as Strataprop, Assetmonk, Myre Capital, hBits, Yield Asset and Definiti.re offer a variety of property deals. Instead of crores, the ticket size is much lower at Rs 25 lacs for a share in property of your choice. When you own a share of the property, you receive proportionate rental yield at specified time intervals without being involved in day to day management of the property in question. The rental yield is claimed to be 7 to 9 per cent per annum and IRR (Internal Rate of Return, which is average annual rate of return that accounts for both rental returns and capital appreciation)is advertised to be between 15 and 18 per cent. But here again there are risks, as these platforms are generally operated by companies that are registered with Registrar of Companies and only some display RERA license on their website. Some of them charge annual professional charges of 1 to 2 per cent of the ownership amount; yet others charge 0.5 to 1per cent and performance fee if returns are above a specified rate. REITs (Real Estate Investment Trusts) listed on the stock exchanges which are regulated by SEBI seem to be a better and safer option for investing in real estate. Now with a lot size of just 200 units, listed REITs provide passive commercial real estate exposure with as low a sum as Rs 60000 to 80000.

There are also investment platforms that offer curated investment opportunities in the lease finance area with relatively low minimum investment amount with a “promise” ofstable regular returns. Fractional ownership in physical assets such as vehicles, equipment and furniture could be yours for as low as Rs 20000/-. The platform architecture is similar to real estate platforms, that is, through a SPV (Special Purpose Vehicle) structured as a company or LLP (Limited Liability Partnership). The investment tenures are shorter between 18 and 48 months depending on the nature of the leased assets. Some platforms charge management fee of 2 per cent and some do not allow premature exit. LLP platforms claim that payment to investors are made post tax. The argument is that return of capital or distribution of profits from LLP is tax exempt in the hands of the partner of the LLP. Since the investment and income is through the lease arrangement, it is important to clearly understand how the lease agreement is drafted. The advertised IRRs for recent deals is in excess of 20 per cent.

One other asset class that offers indirect fractional ownership is covered bonds. They are instruments of refinancing through a form of securitization. A loan pool is formed of the loans given to businesses and individuals by a financial institution. This loan pool is the cover, that is, collateral against which the covered bonds are issued. Such bonds assure a fixed rate of interest and may have a kickerthat will be triggered if there is a “credit event” to compensate for the higher risk. Some bond issuers, in a bid to make the bonds more tax efficient have attempted to link bond returns to a reference index such as an equity benchmark. If the index drops below a specified level you will only get back your principal. By market linking the bond, your income from bond, it is claimed, will no longer taxed at your slab rate and will attract tax as in the case of equities. It is essential to note that covered bonds are complex instruments and they are often resorted to by low rated (i.e., high risk) issuers. Essentially by buying a covered bond you become a lender to bond issuing NBFC who might be offering 11 per cent plus returns with minimum ticket size as low as Rs 10000/-. Before getting swayed by the ease that tech enabled platforms offer, the modest ticket size and comparatively high returns, it is imperative that investors exercise due diligence, carefully go through bond information memorandum, assess the business prospects and the reputation of the issuer.

Alas! Investment is more than science. Financial wizardry coupled with technology would have successfully grasped the binary soul of the transactional dynamics but not the quantum weirdness of human psychology.