KLCI: A Change in Free-float Methodology

Our KLCI sank deeper today after news of EU leaders taxing bank deposits in order to part-fund the bailout of Cyprus created renewed worries among investors worldwide. This came after a huge sell-down on the last 10 minutes of the trading session on Friday, believing to be due to portfolio rebalancing by funds that track the performance of our index as the methodology used in calculating the weightings of the index constituents will be changed effectively on the 18th of March. The shocking moves by EU leaders, coupled with the election fear that has been lingering since late January, is expected to send our CI lower to test the 1600 psychological support again. While our index is moving into the oversold territory and today’s candlestick is forming a long tail, indicating a possible reversal, we should be mindful that the sentiment is weak currently and any release of unfavourable news might bring our index to a lower low. Do trade cautiously.

Let us discuss more on the new FTSE free-float methodology used in calculating the weightings of the index constituents since no detail explanation is provided by any of the publication. Previously, under the free-float banding structure, the weight of each index constituents is adjusted by a float factor as determined by the table below.

Banding Structure

If the free floats (total number of shares available to the public) of a company stands at 18% of the total number of outstanding shares, the market capitalisation (mkt cap = share price X total outstanding shares) of the company will be adjusted by a factor of 20%. Under the new free-float methodology, however, the actual free float percentage (18%) will be used as its factor. The change in methodology is mainly to mitigate the huge change in effective weight when the actual free float change is relatively smaller (Imagine what would happen under the old banding structure when the free floats of a share increases from 74% to 76% . Yes, the effective factor used to adjust its weight in the index will change from 75% to 100%, causing the share to be greatly overweighted). HWANGDBS Vickers Research had provided a detail report on the impact of the revised free-float methodology on the relative weight of each KLCI constituents, which you can read it here.

To get a better picture of the difference between the 2 methods, let us look at some calculations. Assuming that index XYZ comprises of 3 shares – B, C, and D – and the number of shares that are available to the public for each shares are 41%, 74% and 80% respectively. Under the previous banding structure, we use 50% as the free float factor when calculating company B’s weighting in index XYZ since the number of free floats of company B falls under the 50% free float band. The detail calculation of B’s weighting would be as follow,
mkt cap - bandUnder the new structure, where the actual free float will be used, the calculation of company B’s weighting would be,

mkt cap - actualUsing the actual free float factor is said to better reflect the weightings of each index constituents and will reduce unnecessary turnovers when the share moves from one free float band to another due to changes in the company’s shareholder’s structure. To understand more on the limitation of the free-float banding system as well as the rationale of changing the free-float methodology  to the current actual free float, you may be interested in reading the FTSE Free Float Methodology Change FAQ.  Hope you find the explanation and the various sources provided here helpful in clearing your doubts on the new formula in calculating the weightings of our index constituents. Do share this article around to clear the doubts of others too =)

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