XTR 100 – the broad Index

XTR 21 is market cap and fundamental weighted index. And to make it more replicable (tradable) we have studied the underlying free float for the market, to introduce the benchmarks FREE FLOAT version. Moreover the current statistics do suggest that XTR 21 could better its performance with a free float review.
However, since this will be the first attempt to create a free float benchmark in the country we wanted to be devote it some more time. And since we are in an emerging market, it is necessary to consider if float adjustment alters the structure, return characteristics, composition, liquidity and risk profile of the indices. Float adjustment reduces market capitalization of different stocks by different amounts, and might, therefore, alter index structure. To capture the change in relative weights in the full list of index constituents, we have plotted the sectoral free float rankings. This helps us understand the homogeneity and other characteristics of the universe free float.
From a sector rotation perspective, Financials are the top free floating sector at 69%. This might look coincidental, but considering Financials are the early economic cycle, a higher tradability and outperformance owing to high public appeal can only be balanced through a higher free float share. Industrials, Discretionary and Pharma are the other top free float share sectors. Materials, Energy and Utilities are low on the free float share. And if sector analogy is extended to these late economic sectors, market forces might effect an improvement here. Just like the market universe, Energy and Financials are the two top sectors in free float as a percentage of market capitalization. Another interesting aspect was the large capitalization free float at 79%. Mid capitalization and small capitalization free float share stood at 12% and 10% respectively. This statistics once again reinforces our large cap hypothesis (XTR.250208) and suggests that free float factors might reinforce XTR 21 positively. We also plotted the free float shares for Late Expansion, Early Expansion and Middle Expansion economic cycles. We have carried the annexure with the free float rankings (slide 14). Bank of Transylvania (BATR.BX) is top free float stock, followed closely by SSIF BROKER (BRKU.BX) and Transportation Major SOCEP (SOCC.BX) at 85%, 77% and 66% respectively. MECHEL (OTSP.BX) is the lowest free float stock ruling at 0.2.
We will delve on the real construction in the next issue of XTR. This week we are introducing the Free-float (FF) factor and how numeric ranking for BVB stocks can be based on Free flat factors. The FF methodology refers to an index construction methodology that takes into consideration only the free-float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in Index. Free-float market capitalization is defined as that proportion of total shares issued by the company that are readily available for trading in the market. It generally excludes promoters holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course. In other words, the market capitalization of each company in a Free-float index is reduced to the extent of its readily available shares in the market. 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.
There are many advantages of Free-float Methodology. It 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. And it enables passive managers to track the index with the least tracking error. Free-float Methodology improves index flexibility in terms of including any stock from the universe of listed stocks. This improves market coverage and sector coverage of the index. For example, under a Full-market capitalization methodology, companies with large market capitalization and low free-float cannot generally be included in the Index because they tend to distort the index by having an undue influence on the index movement. However, under the Free-float Methodology, since only the free-float market capitalization of each company is considered for index calculation, it becomes possible to include such closely held companies in the index while at the same time preventing their undue influence on the index movement.
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. 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 Foreign Institutional Investors (FIIs) to track Indian equities, is also based on the Free-float Methodology. NASDAQ-100, the underlying index to the famous Exchange Traded Fund (ETF) – QQQ is based on the Free-float Methodology.
To construct the free float index, one needs to determine the Free-float factor for each Index Company. A few exchanges around the world have designed a detailed Free-float format to be filled and submitted by all index companies on a quarterly basis with the Exchange. 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.
Apart from the free float factors, a few other considerations need to be explored. The first is breadth of coverage — how complete is the benchmark in covering the investment opportunity set? Does it take into account the sector rotation cycle? Does the index accurately reflect what the investor can actually buy? The second is transparency of construction — the portfolio construction rules should be clear and unambiguous. These rules ought to be predictable and consistently applied. We will try to address all these issues in the following issues of XTR. Owing to some special ownership rules, free float issues regarding SIFs are unclear and how to determine the free float factor for the respective stocks. The free float data taken for XTR was reported on 29 Feb 2008.
About the XTR21 performance week over week, the benchmark outperformed all the other indices.
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