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| The weightage of scrips forming the Sensex will change from September 1. Most market analysts believe its impact will not be significant, but some see volatility increasing in the short term
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| Come September 1, India's most popular benchmark index, the BSE Sensex, will shift to the free-float methodology. This paradigm shift in indexing may not mean much in terms of weightage changes for the companies that constitute the index.
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| But what it does signify is a shift in focus from the current market capitalisation-based index to a benchmark that reflects the real-life investible opportunity available to investors.
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| How will the change affect the Sensex's current constituents? Not very much. As per the closing prices and market capitalisation on August 20, HDFC (+2.03%), Infosys (+1.69%) and ICICI Bank (+1.55%) are set to be the biggest gainers in terms of weightage in the index under the new regime.
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| As for the losers, HLL (-2.96%), SBI (-1.60%) and Reliance Industries (-1.20%) top the list, because of the large chunk of promoter or strategic holdings in these companies (see table on weightage changes).
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| What does this mean for their stock prices? Prices are likely to show slight volatility as fund managers benchmarking their portfolios against the Sensex make alterations to realign their portfolio close to the benchmark. However, market players are of the view that things are unlikely to change drastically.
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| The only question-mark is about volatility. "Under the new system, volatility could increase", says Hiten Jhaveri, director of Stockwhizo.com.
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| "A major chunk of shareholdings in most Indian companies is held by promoters. Once you take them out of consideration under the free-float methodology there is bound to be an increase," Jhaveri says.
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| P V K Mohan, fund manager of IL&FS mutual fund's index fund, says he will need to make only a one-time reshuffle of his portfolio after the free-float regime is ushered in.
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| "The new system will represent the picture more accurately, removing the earlier bias for large-cap companies with low free-floats. As an index fund manager I'll sell some shares whose weightage has come down, while buying some whose weightage has gone up", he says.
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| While it is more than likely that in the immediate aftermath of the shift selling and buying pressure from funds and other institutional investors could lead to a fair bit of volatility in the markets, nothing will change once the one-time rebalancing of portfolios is done with.
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| "Index funds and ETFs (exchange-traded funds) will be the ones to be impacted mostly, and they'll have to make the changes in their respective portfolios", says Tridib Pathak, fund manager at Principal Mutual Fund.
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| What about other equity funds? "The effect will not be much", says Pathak. "There is not going to be any major change as far as equity fund managers are concerned. Even though there will be changes in the market capitalisation of the index constituents and, thus, their weightage in the index, the change is not so large as to have any dramatic impact on prices", he adds.
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| Besides, domestic mutual funds have assets of around Rs 600 crore in index funds and only about 50 per cent of them are based on the Sensex. So, there is unlikely to be any major impact on prices due to the rebalancing of index portfolios, say fund managers.
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| What about foreign institutional investors (FIIs)? The same holds true for them, too. As far as FIIs are concerned, the change may not mean much since they already track the MSCI India Standard Index which follows the free-float methodology.
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| So, there is unlikely to be any major rebalancing from their side either. According to U R Bhat, head of broking, JP Morgan, the FIIs are well-used to the concept of free-float.
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| "The shift to a free-float index is a step in the right direction, since it mirrors the reality. Retail investors stand to gain since they can benchmark their portfolio performance against real investing opportunity", he adds. That could well be the biggest plus point of the shift.
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| There have been murmurs for some time that the current method of computing the Sensex does not reflect the real investible opportunity available to investors.
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| That is about to change. "Apart from aligning the Sensex with the best global practices in index construction, a transition from full market-cap base to a free-float method will ensure that the basic characteristics of the Sensex will be retained", says Hitesh Porwal, who is in charge of BSE's index cell.
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"The new method will also improve the benchmarking qualities of the Sensex without disrupting its historical continuity", he adds. Stock indices serve two purposes
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