Discussion note on free float weighting schemes
Norges Bank Investment Management has published a discussion note on the implications of using free float weighting schemes in global equity portfolios.
10 September 2014
The free float of a company is defined as those shares that are readily available for trading, the remaining being held by governments, owners, insiders and other special types of investors. In recent years, free float weighting has largely replaced total market capitalisation as the dominant equity index weighting scheme. The Fund’s strategic equity benchmark, the FTSE Global All Cap Index, is also free float weighted.
In this note, we examine the key implications of using free float-adjustments in global equity portfolios relative to full market capitalisation weights. Both weighting schemes have their pros and cons. Market capitalisation weights can be justified on a theoretical basis, are readily available, easier to calculate, and better represent the relative economic importance of the companies in the portfolio.
The disadvantage of market capitalisation weights is that they do not take into account the trading opportunities in the market and may increase transaction costs. The free float weights mitigate the investability problem but also change the geographic and industry composition of the portfolio and tilt it away from the value, small-cap and less liquid stocks which have been documented to command premia over the long run. This is difficult to justify from a return-maximisation perspective in the case of a long-term investor with no immediate liquidity needs.