Sensex will shift to free-float system

India's equity benchmark Sensex BSE Sensitive Index of the Bombay Stock Exchange BSE will see a major change in the way it8217;s calcul...

India8217;s equity benchmark Sensex BSE Sensitive Index of the Bombay Stock Exchange BSE will see a major change in the way it8217;s calculated. From September 1, 2003, Sensex will be calculated based on the free-float methodology as against the current practice of the full market capitalisation system.

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. 8216;8216;It generally excludes promoters8217; 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 capitalisation of each company in a free-float index is reduced to the extent of its free-float available in the market,8217;8217; the BSE said.

Ready for change

MARKET CAP SYSTEM: The total market capitalisation of a company, irrespective of who is holding the shares, is taken into consideration for computation of an index

FREE-FLOAT SYSTEM: Shares issued by the company, which are readily available for trading in the market are considered. It excludes promoters8217; holding, government holding, strategic holding and other locked-in shares

Under the 8216;full-market capitalisation8217; methodology, the total market capitalisation 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 capitalisation, only the free-float market capitalisation of a company is considered for index calculation, it is called the free-float methodology.

This means for a company like Hindustan Lever, only 49 per cent of its capital listed on the stock exchange will be used for calculation of Sensex in the free float system. As 51 per cent is held by its promoter Unilever, this part will not be included for index calculation. Similarly, in SBI, as the majority stake is held by the RBI, only the public holding will be calculated.

Internationally, all the major index providers have shifted to the free-float methodology. Morgan Stanley 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 8212; QQQ is based on the Free-float methodology. FTSE, Dow Jones, S038;P, STOXX and other index providers are also using the free-float methodology.

A free-float based index is regarded as a better benchmark in comparison to a full market capitalisation weighted index. It not only reflects the market trends in a more rational manner, but also aids both active and passive investing styles. 8216;8216;It aids active managers by enabling them to benchmark their fund returns vis-a-vis an investable index. This enables an apple-to-apple comparison thereby facilitating better evaluation of performance of active managers,8217;8217; BSE says.

Story continues below this ad

8216;8216;It avoids the undue influence of any closely-held large-capitalisation stock on the index movement. For example, almost 85 per cent of Wipro it8217;s not a Sensex stock is held by its promoter Azim Premji. Its market cap is huge but floating stock is less,8217;8217; said a dealer.