MSCI smooths the way for free float switch
MSCI has finally announced that it is to recalibrate its global equity indices for free float – representing the portion of shares that are actually available to the market – in a move likely to have a huge trading impact as investors adjust their portfolios.
Estimates for assets benchmarked against MSCI indices come out at around $3trn (e3.6trn) with the indexed portion in the $600bn area.
Consequently, the switch will be implemented in two phases, the first at the close of November 2001 and the second by the end of May 2002.
MSCI’s methodology will operate on the principle of a 5% band weighting. An index constituent’s inclusion factor will be equal to its estimated free float rounded up to the closest 5% for stocks with above 15% free float. A stock with a free float of 23.2% will appear in the index at 25% of its market cap.
Indices provider Salomon Smith Barney has operated a free float weighting system for around ten years, which it claims is 100% accurate. FTSE meanwhile is currently shifting to a free float system, which will operate on a broader weighting band of approximately 15%.
Giacomo Fachinotti, member of the MSCI index committee in Geneva, notes that the move is the result of consultation with investors world-wide: “The 5% figure reflects the importance of being close to the estimated free-float numbers, but not to the point where the last percentage counts or there is a case of micro turnover. We also wanted to avoid the big swings that could be created by modest changes in flow within large companies. The two-phase approach ensures that implementation can be digested and made in an orderly fashion. There may be some disadvantages for investors close to the index, but I am sure they are going to weigh that against the advantages – less turnover and, hopefully, less market impact.”
MSCI has also announced that it will increase the coverage of its Standard Index series from 60% of total market capitalisation to 85% of free float adjusted market cap. It says the move reflects increased market concentration and will provide greater diversification and representation of market opportunities.
Gareth Parker, head of index design at FTSE in London, is critical of MSCI’s approach. “It’s a bit amusing that they have spent two years watching everyone else do this and then gone down, broadly speaking, the same route.”
He believes MSCI has made a number of mistakes: “Their two phase approach is to say that in eight months time they’ll do half the changes and then another year later they’ll do the rest – so there will be a cost issue because investors may have to make massive portfolio trades twice.
“There could also be the situation where investors will have to sell one stock in the first phase and then buy some of it back in the second phase because the free float has changed.”
The 5% band structure, he says, could also pose problems.
“If a stock, for example, has a 39.9% float weight, which would be rounded up to 40%, then it only has to move by another couple of per cent before it is rounded up again.”
MSCI will publish its revised index constituents and their inclusion factors by June 30, before running a provisional series reflecting the changes.
Details will be available at www.msci.com.