Since Orion Advisor Services launched its direct indexing tool two years ago, more than half of the 70 RIA clients using it have asked Chris Romano, the firm’s quantitative portfolio risk manager, the same question: Can we offer this to our smaller clients?
Until now, Romano’s answer has been no. As long as clients have to purchase whole shares, direct indexing is expensive.
Accounts with less than $400,000 will generally have to supplement their index replication with ETFs, as some stocks (like Google or Amazon) are over $1,000 per share.
As for fractional share trading, “that's really the last leg to democratize direct indexing to the world,” Romano says.
While custodian Fidelity — now followed by
“We’re waiting and ready,” Romano says.
Fidelity Institutional is “gauging demand,” according to a company spokeswoman, while Schwab says the capability should be available to advisors “in the next month or so.”
Until fractional share trading is made available to advisors, only high-net-worth clients at RIAs custodying with Fidelity or Schwab have access to what Romano says can be a powerful investment strategy (the average account size of Orion’s direct indexing tool, dubbed
Direct indexing allows clients to customize their portfolios. They can choose to leave out certain stocks or add others to their investment strategy. Clients passionate about things including the environment or gender equality can exclude certain companies from their portfolio.
The strategy can also be incredibly tax efficient, Romano says. Advisors can sell off client stock positions when they are running at a loss, offsetting gains incurred trading the account.
There are at least four custodians that already offer fractional share trading to RIAs, making direct indexing possible for smaller accounts — Folio Institutional, BNY Mellon Pershing, Apex Clearing and, most recently, Interactive Brokers. The robo advisor
“It's an incredibly efficient way for advisors to deliver mass customized investment solutions,” says Greg Vigrass, president of Folio Institutional, which has offered fractional share trading for
“Regardless of whether a client has $10,000, $100,000 or $10 million to be invested into that model, they're going to own all of the securities at the exact precise weights of the model,” he says.
Fractional share trading can also make clients stickier. If clients decide to switch firms and custodians, they’d have to liquidate fractional positions, according to Allan Roth, founder of the RIA Wealth Logic and contributor at Financial Planning, which would encourage clients to stay with their financial advisor.
“I think it could become more popular than indexing,” he says.
‘A lot of math’
But with that popularity would come hurdles, according to Dustin Kirkland, chief product officer at Apex Clearing, which launched a fractional share trading API two years ago. It’s not easy to make fractional share trading available, he says.
“It’s ultimately a lot of math,” Kirkland says, explaining that with fractional shares come complexities that may not initially come to mind: What about proxy voting? Dividends?
“You're the one buying the full shares,” he says, speaking of custodians and brokerages, “and then you're distributing it out to [end clients].”
Apex always keeps one to two shares of every symbol it offers on hand so that it can fill a fraction of an order at any time without having to go to the market, Kirkland says. Right now, Apex offers some 3,000 symbols. By the end of the year, it will offer over 5,000, he says.
“We get requests sometimes that we can't, or we won't, put onto our books,” Kirkland says. “And these are pink sheets or bulletin board stocks or penny stocks, or something like that.”
Not for everyone
Current retail brokerages are now geared more toward the small investor, suggests Roth. It’s a way for the companies to attract college graduates and young clients in the expectation that they’ll become more lucrative over time. But he wonders whether it’s an initial move toward something more. “My hypothesis is they’re doing it as a step to get to direct indexing,” Roth says.
Fidelity and Schwab both say they are evaluating demand for fractional share trading on the RIA side.
“Based on conversations with independent advisors, the ability to trade fractional shares on behalf of their high-net-worth clients is not a critical capability,” Schwab spokesman Rob Farmer said in an email. As for direct indexing, Farmer said the company would “continue to evaluate how fractional share functionality might be expanded to additional stocks and investment vehicles – with a focus on delivering the capabilities clients tell us are most important to them.”
Fidelity spokeswoman Nicole Abbott says the company continues "to address the specific trading needs of our clients in addition to gauging demand for fractional share trading and other trading capabilities.”
To be sure, some advisors say they’re not interested. When asked if he’d use fractional share trading for clients, “the short answer is no,” says Kirk Kreikemeier, a financial advisor at the RIA Pebble Valley Wealth Management.
“If I’m doing a fractional share, I shouldn’t be [managing] that account,” Kreikemeier says, noting that he only trades individual stocks or makes custom indexes for HNW accounts. While he does manage some accounts as small as $20,000, they tend to be IRAs. For taxable accounts, “an ETF is a great solution for it,” he says.
At Pershing, “digital firms are the predominant users” of fractional shares, although it’s available to any RIA, Evan LaHuta, head of client experience for Pershing Advisor Solutions, says in a statement. He adds it’s primarily used to administer proprietary models.
Romano says Orion would be ready to start offering direct indexing with fractional shares today — it’s only a matter of when its custodial partners give it the go-ahead.
“That's something we can get turned on very quickly,” he says.
