Why free float indices?

Ever wondered why free float indices have become so popular of late, particularly, with increasing proliferation of ETFs?

Exchange-traded funds (ETFs) are based on the concept of ‘passive investing’ by just following an underlying benchmark for investment, to reduce cost of research and investment decisions. Simply put, ETF are mutual fund units whose portfolio mimics the composition of a benchmark index like S&P500 by investing in stocks that form the index in the same proportion as the weightage of these stocks in the index. This way, performance of the fund fluctuates with the index performance. ETFs provide investors with facility of a mutual fund with Liquidity like stocks to invest or divest at will in the market. ETFs are the primary customers for licensing indices.

What is free float – free float or investible weight of a stock is the percentage of the total issued shares of a stock that is available for trading or investment (floating) in the market. This factor ignores the portion of a stock held by promoters or VCs or long term investors assuming that it is not available for investment by mutual funds.

By applying the free float while computing indices, most of the dead stock of shares of a company that is not available in the market for investment is ignored from the weightage of the stock in an index. This means it will take less money to buy shares of the company as part of the index portfolio and an ETF can buy more units of an index with relatively less amount. This is the reason ETFs prefer to license a free float index over a plain market-cap index. This also helps the exchanges where these ETFs are traded to earn listing fees and have trading volumes. Most indices in India are currently designed, computed, published and maintained by subsidiaries of one or the other exchange which also controls the availability of trading data. Effectively indices are a controlled business in a way that serves the purpose of exchanges and ETFs. This creates a need for independent agencies for publishing and maintaining indices.

We at Harrier have developed a web-based software product to automate the computation and maintenance of market indices (www.stockpile.in) including free float indices.
I’ll appreciate your feedback and shall be happy to provide additional details.

Thank you for reading!

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