| |
SENSEX to shift to Free-float methodology
A paradigm shift in Indian Indexing
From 1st September 2003, the country's equity benchmark SENSEX will be calculated based on the Free-float methodology. Currently, the SENSEX is calculated based on the full market capitalization methodology.
Globally, the Free-float methodology of index construction is considered to be an industry best practice and all major index providers like MSCI, FTSE, S&P and STOXX have adopted the same. The MSCI India Standard Index is also based on the Free-float methodology.
In India, BSE pioneered the concept of Free-float with the launch of the country's first Free-float based index- BSE TECk in July 2001 and BANKEX in June 2003. The shifting of SENSEX to this methodology is a culmination of successful experiences with these two indices and a series of debates and discussions in the last few years. It may be recalled that in order to generate a nationwide debate on the issue of Free-float, BSE had organized a "Roundtable on Free-float Index" in March 2002, which was chaired by Mr. Mark Makepeace, President and CEO - FTSE Group. The Roundtable was followed with a series of discussions with a cross section of market participants. The feedback was overwhelming for shifting benchmark indices to the Free-float methodology.
The new methodology would align the SENSEX with the best global practice in index construction. A smooth transition from Full market capitalization to Free-float market capitalization methodology would ensure that the basic characteristics of SENSEX are retained. Importantly, the Free-float methodology will further improve the benchmarking qualities of SENSEX while maintaining its historical continuity. (Annexure 1 - FAQs on Free-float methodology)
The following Free-float factors will be applied to the SENSEX companies. A Free-float factor of say 0.9 means that only 90% of the total market capitalization of that company would be taken into consideration for index calculation.
|
ACC LTD. |
0.9 |
HINDUSTAN LEVER LTD. |
0.5 |
|
BAJAJ AUTO LTD. |
0.8 |
HINDUSTAN PETROLEUM CORP LTD |
0.5 |
|
BHARAT HEAVY ELECTRICALS LTD. |
0.4 |
ICICI BANKING CORPORATION LTD. |
1.0 |
|
BSES LTD |
0.5 |
INFOSYS TECHNOLOGIES LTD. |
0.8 |
|
CASTROL |
0.3 |
ITC LTD. |
0.7 |
|
CIPLA LTD. |
0.7 |
LARSEN & TOUBRO LTD. |
0.9 |
|
COLGATE PALMOLIVE (INDIA) |
0.5 |
MAHANAGAR TELEPHONE NIGAM LTD |
0.5 |
|
DR REDDY'S LABORATORIES LTD. |
0.8 |
NESTLE INDIA LTD. |
0.5 |
|
GLAXO LTD |
0.6 |
RANBAXY LABORATORIES LTD |
0.7 |
|
GRASIM INDUSTRIES LTD |
0.8 |
RELIANCE INDUSTRIES LTD. |
0.6 |
|
GUJARAT AMBUJA CEMENTS LTD |
0.8 |
SATYAM COMPUTER SERVICES LTD. |
0.9 |
|
HCL TECHNOLOGIES LTD. |
0.3 |
STATE BANK OF INDIA |
0.5 |
|
HDFC LTD. |
1.0 |
TATA ENGG & LOCO CO. LTD. |
0.6 |
|
HERO HONDA MOTORS LTD |
0.5 |
TATA IRON & STEEL CO. LTD. |
0.8 |
|
HINDALCO INDUSTRIES LTD |
0.8 |
ZEE TELEFILMS LTD. |
0.5 |
FAQs on Free-float Methodology
- What is a Free-float index?
Currently all equity indices in India, except the BSE-TECk Index and BANKEX, are calculated using the 'full-market capitalization' methodology. Under the 'full-market capitalization' methodology, the total market capitalization of a company, irrespective of who is holding the shares, is taken into consideration for computation of an index. However, if instead of taking the total market capitalization, only the Free-float market capitalization of a company is considered for index calculation, it is called the Free-float methodology. Free-float market capitalization 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' holding, government holding, strategic holding and other locked-in shares, which will not come to the market for trading in the normal course. Thus, the market capitalization of each company in a Free-float index is reduced to the extent of its Free-float available in the market.
- Is Free-float SENSEX a new Index?
No, Free-float SENSEX is not a new Index. It is the same old 30 stock Index calculated on a more scientific and globally accepted methodology.
- Will the new methodology change the SENSEX value on the day of implementation?
No, there will be no change in the SENSEX value due to the change in the methodology. The SENSEX will continue to reflect the market in the same fashion, as it has been doing currently.
- Why a Free-float based Index?
A Free-float based index is regarded as a better benchmark in comparison to a full market capitalization weighted index. It not only reflects the market trends in a more rational manner, but also aids both active and passive investing styles. It aids active managers by enabling them to benchmark their fund returns vis-à-vis an investable index. This enables an apple-to-apple comparison thereby facilitating better evaluation of performance of active managers. 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.
- What are the major advantages of a Free-float Index?
- A Free-float Index reflects the market movements better.
- It aids passive investment because a Free-float index is easily replicable
- It improves index flexibility and the resultant market coverage and sector coverage
- It avoids the undue influence of any closely-held large-capitalization stock on the index movement
- It is considered as a global best practice in index construction.
- Is Free-float a globally accepted indexing methodology?
Internationally, all the major index providers have shifted to the Free-float methodology. MSCI, a leading global index provider, shifted all its indices to the Free-float methodology in 2002. The MSCI India Standard Index, which is followed by FIIs to track Indian equities, is also based on the Free-float methodology. NASDAQ-100, the underlying index to the famous ETF - QQQ is based on the Free-float methodology. FTSE, Dow Jones, S&P, STOXX and other index providers are also using the Free-float methodology.
- Are there any Free-float indices in India currently?
Yes, currently there are two indices based on the Free-float methodology. BSE TECk Index, launched in July 2001, was the country's first Free-float index. Recently on 16th June 2003, BSE launched BANKEX, a benchmark for the banking sector stocks also based on the Free-float methodology.
- How does BSE determine the Free-float factor for each Index Company?
BSE has designed a detailed Free-float format to be filled and submitted by all index companies on a quarterly basis with the Exchange. (Format available on www.bseindia.com) The Exchange determines the Free-float factor for each company based on the detailed information submitted by the companies. Free-float factor is the multiple with which the total market capitalization of a company is adjusted to arrive at the Free-float market capitalization. Once the Free-float factor of a company is determined, it is rounded-off to the higher multiple of 10 and each company is categorized into one of the bands given below. The banding structure reduces the potential of frequent changes in Free-float factors of index companies. A Free-float factor of say 0.6 means that only 60% of the market capitalization of the company will be considered for index calculation.
|
Free-float Market Capitalization |
Free-float Adjustment factor |
|
10-20% |
0.2 |
|
20-30% |
0.3 |
|
30-40% |
0.4 |
|
40-50% |
0.5 |
|
50-60% |
0.6 |
|
60-70% |
0.7 |
|
70-80% |
0.8 |
|
80-90% |
0.9 |
|
90-100% |
1.0 |
July 18, 2003
|
|
