Many times it has been seen that the National Stock Exchange (NSE) benchmark index, closes in the positive while the Bombay Stock Exchange (BSE) benchmark index, the Sensex, in the negative or vice a versa. Out of the 98 trading sessions in the current calendar year till 22 April 2009, the Sensex and the Nifty closed in different territories on five to six occasions: one in the red and the others in the green.One of the major reasons for this anomaly is the fact that both the indices follow different methodologies for calculation of index values. The Nifty is based on full market-capitalisation weightage, while the Sensex follows the free-float market-capitalisation methodology. 

Interestingly, the NSE, the country’s largest cash and derivatives exchange, has announced that it would adopt the free-float methodology to calculate its benchmark index S&P CNX Nifty and also a few other indices. This shift would take the Nifty closer to market realties and make it a more appropriate benchmark. The NSE’s free-float methodology to calculate weightage would come into effect from 26 June 2009. Three indices — CNX Nifty, CNX Defty and CNX 100 Index — would migrate to the new methodology. The CNX Nifty Junior Index is to switch over to the free-float methodology from 4 May 2009.Certain categories of shares would be excluded from the free-float factor. These include government holding in the capacity of strategic investor, shares held by promoters through ADR/GDRs, strategic stakes by corporate bodies, investments under foreign direct investment (FDI) category, and equity held by associate/group companies (cross-holdings).

What Does Free-Float Methodology Mean?

A method by which the market capitalization of an index’s underlying companies is calculated. Free-float methodology market capitalization is calculated by taking the equity’s price and multiplying it by the number of shares readily available in the market. Instead of using all of the shares outstanding like the full-market capitalization method, the free-float method excludes locked-in shares such as those held by promoters and governments.

Calculated as:

      FFM=Share Price x (No. of Shares Outstanding – Locked In Shares) 

EquityPandit.com explains Free-Float Methodology as:

The free-float method is seen as a better way of calculating market capitalization because it provides a more accurate reflection of market movements. When using a free-float methodology, the resulting market capitalization is smaller than what would result from a full-market capitalization method. 

Free-float methodology has been adopted by most of the world’s major indexes, including the Dow Jones Industrial Average and the S&P 500.

Conversely, once the Nifty shifts to free-float methodology, weights of companies like Reliance, ICICI Bank, L&T, HDFC, ITC and HDFC Bank would increase considerably, while weights that of companies with high promoter stake such as Wipro, DLF, ONGC and NTPC would fall drastically.