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Sensex migrates to free float capitalisation

BS Markets Bureau in Mumbai | September 02, 2003 10:02 IST

The Bombay Stock Exchange Sensex on Monday shifted to the free-float market capitalisation method with major changes in the relative weightages of the 30 scrips.

In the current avatar, the Housing Development Corporation is the biggest gainer with its weightage rising 1.84 percentage points, according to a BSE press release.

Infosys Technologies is the next big gainer, with its weightage going up by 1.70 percentage points. ICICI Bank, Larsen & Toubro, Satyam Computer and Dr Reddy's Laboratories are the other big gainers.

Hindustan Lever Ltd, State Bank of India, Reliance Industries Ltd, Hindustan Petroleum, HCL Technologies, Bharat Heavy Electricals and Mahangar Telepone Nigam Ltd have each lost in relative weightages.

Rushabh Sheth, senior vice-president and head, equity investments, Kotak Mahindra Mutual Fund, said, "The weightages of RIL, SBI and HLL have gone down, while that of ICICI Bank has gone up. This will lead to a reallocation of portfolios by index funds benchmarked against the Sensex."

A free-float market capitalisation-based index is regarded as a better benchmark in comparison to a full-market weighted index.

It not only reflects the market trends in a more rational manner, but also props both active and passive investing styles, the BSE said.

Sanjay Sinha, fund manager (equity), UTI Mutual Fund, said: "Though in the short-term fund managers would have to incur additional costs to realign their portfolios with the index, a free-float method is considered the best practice in index construction globally."

Also, a free-float index reflects market movements better and supports passive investment styles because it is easily replicable. Further, it also avoids the undue influence of any closely-held large-capitalisation stock on the index movements.

Globally, the free-float methodology of index construction is considered to be the industry best practice and all major index providers such as the Morgan Stanley Capital International, FTSE, S&P and STOXX have adopted the same.

The MSCI India is also based on the free-float methodology. "With the Sensex going free-float, a number of foreign funds would benchmark their portfolio to the Sensex now. Also, foreign funds wanting to build a portfolio of Indian stocks could now look at the Sensex." UTI MF's Sinha added.

Most active managers benchmark their fund returns vis-.-vis an investable index. Being a perfectly replicable portfolio of stocks, a free-float adjusted index is best suited for the passive managers as it enables them to track the index with the least tracking error.

Free-float market capitalisation is defined as that proportion of total shares issued by the company which are readily available for trading in the market.

It generally excludes promoters' and government holdings, strategic holding and other shares under any type of lock-in clauses, which will not come into the market for trading in the normal course.

Thus, the market capitalisation of each company in a free-float index is reduced to the extent of its free float available in the market.

The free-float factor is the multiple with which the total market capitalisation of a company is adjusted to arrive at the free-float market capitalisation.

Once the free-float factor of a company is determined, it is rounded off to the higher multiple of 10 and each company is categorised into percentiles.

The banding structure reduces the potential of frequent changes in the free-float factors of index companies.

A free-float factor of say 0.6 means that only 60 per cent of the market capitalisation of the company will be considered for index calculation.

For example, if the free-float factor of a company is initially determined at 46 per cent, a factor of 0.5 will be applied.

This will reduce the need for frequent changes in the free-float factor unless the free-float crosses either the lower or the upper band by two percentage points.

In this case, no index adjustment will be required unless the free-float moves beyond 52 per cent on the upper side or below 38 per cent on the lower side.

Thus, the index will remain stable despite small changes in the free float.

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