FTSE is dedicated to providing its clients with the most accurate, predictable and transparent picture of the global market. It will come as no surprise, therefore, that FTSE was the first major index provider to join the current debate on free-float adjustment with the launch of its pioneering market-consultation exercise in July 1999.
The potential dangers of ignoring free-float availability are clear: share weightings that do not accurately reflect availability of stock in the market lead to price distortions and stock shortages for funds. At the same time, adopting a methodology of precise free-float weighting has its own disadvantages, such as the cost of constant portfolio rebalancing. Table 1 shows that there is a difference in free float availability between the three regions of the world as defined by the FTSE All-World Index.
Made by the market, for the market
FTSE recognises that the right balance must be found between ensuring accurate free-float representation and minimising turnover costs. After many months of working closely with the market, we have developed a banded weighting approach that achieves this objective. The banding is narrow at the lower end of the scale (50% free float or below), where greater sensitivity is required. At the higher end of the scale (above 50%), where less sensitivity is required, broader bands are applied so that the weightings of companies do not fluctuate unless a significant corporate event has occurred. Table 2 shows how the weighting bands are applied.
The banding methodology serves a dual purpose:
q To insulate market practitioners from minor fluctuations in available free float and the expense of portfolio management costs;
q To reflect change only when the change has a significant impact on share availability.
Index providers who have opted for a precise free-float adjustment, will see their constituents subject to frequent rebalancing in response to relatively immaterial free-float changes unless they delay or combine changes. Free float updated once a year is no longer ‘precise’ – it is out of date. A comparison of implementing free float shows FTSE indices having a substantially lower turnover.
FTSE has also considered how those tracking and benchmarking against our indices can best implement the changes that the switch to free float will entail.
Our policy for moving towards free-float adjusted indices was published in August 1999 and has been effective from January 2000. Since that date, all new index constituents have been free-float adjusted as and when they enter a FTSE index. The majority of countries in the FTSE All-World Index (including all of the emerging markets) have already been free-float adjusted. Existing constituents will be adjusted on 18 June 2001, meaning that all FTSE indices will be free-float adjusted from this point.
FTSE is providing extensive* notice of the free float bandings to be applied to existing index constituents to minimise change-over costs. Details of the bandings for each constituent are published on the FTSE website (www.ftse.com), allowing clients to track the impact of the switch on their portfolios in preparation for implementation on 18 June 2001. Subsequent banding changes applied to constituents will be determined by the rules governing the relevant index and ratified by the governing committee.
Listed in Table 3 is a comparison of
the current status of the major index providers in the move to introduce free-float weighting.
A transparent approach
FTSE’s core values of transparency, accuracy and predictability will remain as we introduce the most cost-effective application of free float, without compromising or distorting the accuracy with which the index represents.
Available free-float is calculated using publicly available information. Once a stock has been selected for an index according to its full market capitalisation, it is then weighted within that index according to its free float availability.
Within the ground rules for each of our indices, there are clear criteria for the free-float adjustment of a company. These rules can be found on www.ftse.com and are also available from the FTSE client services department on +44 (0)20 7448 1810.
FTSE has also produced a white paper detailing our approach to free float which contains a more thorough explanation of our methodology and includes market-impact analysis. This is available on request from FTSE client services department or on request from www.ftse.com.
Mark Makepeace is managing director of FTSE
*Indicative free-float weightings for UK index constituents have been determined and are already published. Indicative free-float bands for European index constituents will be published no later than December 2000 and the indicative bands for the remainder of the FTSE All-World Index constituents no later than 18 March 2001.
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