I have been looking into motif investing. They say they allow fractional shares. How do they clear fractional shares on their side of the trade? Let's say I buy 0.5share of AAPL, I don't know any other broker selling 0.5 shares, thus they should be buying full share. Unless they are finding another buyer who is willing to also buy 0.5 share at the same time as me, they should be taking on market exposure for the rest of fraction of the share that I am not paying for.
Who cares how they do it, as long as you own the half share? I assume they aggregate all the shares they hold across the whole firm and hence are at most long or short up to 0.5 of a share of each stock. Likely a rounding error in terms of exposure, and they could hedge it with SPY or something if they really wanted.
Why they are at most 0.5 share long/short? If I buy 0.01 share they will be long 0.99 share. Also SPY is the market portfolio, if I am always buying a couple of stocks, they cannot hedge exposure due to me by just using SPY. They claim to use an inventory account to balance for client portfolios. Is it common for brokers to hold an inventory portfolio, aren't they taking additional risk? I guess as long as they are not touching your portfolio, regulations do not care how they balance the book??
.99 shares is a trivial amount of risk for them to absorb, even if they need to do this for each of the 8000+ stock-like securities traded in the US. The only security that could be seen as even remotely being an issue, even for a small brokerage, is BRK.A, and that could be hedged with BRK.B. You do bring up an interesting point in that the client apparently doesn't hold a "share" in the normal sense -- my guess is that the client holds something like a contract that they'll give you the returns of the fractional share you own. They must have gotten some sort of special approval from the SEC to do this (or was there already a regulatory framework in place for fractional shares?).
They wouldn't buy the 0.99 of a share, instead just be short 0.01 to you. Once you buy over 0.5, then it's less risk to actually buy it. Just don't ask to vote your half a share and no one will care how it actually works behind the scenes.