What it means
Before this approach became standard, most indices weighted companies by full market capitalisation, which is share price multiplied by every share in issue. The problem was practical rather than theoretical: if a government owns 70% of a listed utility, an index fund tracking a full-capitalisation index would need to buy shares that are simply not for sale.
Free-float weighting fixes the mismatch by scaling each company's weight to its tradable shares. Index providers apply a free-float factor, which is the proportion of shares considered available.
Holdings normally excluded are founder and family stakes, government holdings, cross-shareholdings between companies, employee share plans that are locked, and shares subject to post-listing restrictions. Most providers band the factor, rounding to the nearest 5% for example, and review it on a quarterly or semi-annual schedule.
The commercial consequence is that a very large company can carry a surprisingly small index weight. A newly listed business that floated only 12% of its shares will sit far below its headline size in the index, and its weight will step up as lock-ups expire and further shares are sold.
Analysts who compare index weights to revenue or profit without checking the float will draw the wrong conclusion. Free-float methodology also drives real trading flows.
When a provider raises a company's float factor at a review, every fund tracking that index must buy more of the stock on the effective date, and the reverse happens when a float factor falls. These mechanical flows are large enough that traders position ahead of index reviews, which is why float changes are announced in advance.
There is a nuance worth carrying into meetings. Free float affects the index weight, not the company's actual market capitalisation, so the same company has one full market capitalisation for valuation purposes and a different free-float capitalisation for index purposes.
Confusing the two produces mistakes in relative valuation work and in any calculation of how much of a company an index fund really holds.
In practice
Real-world examples.
Example
A state-controlled telecoms operator lists 18% of its shares. Despite a full market capitalisation that would place it among the ten largest companies in its market, its free-float factor of 0.20 after banding leaves it outside the top thirty by index weight, and passive funds hold correspondingly little of it.
Example
A technology company completes its initial public offering with a 15% float and a 180 day lock-up on founder shares. When the lock-up expires and the provider lifts the float factor at the next quarterly review, index trackers must buy several million additional shares on a single effective date.
Example
A government sells down its residual 25% stake in a listed bank through an accelerated bookbuild. The float factor rises from 0.70 to 0.95, the bank's index weight increases by roughly a third, and passive demand absorbs a meaningful slice of the placing.
Formula
Calculation
Free-float market capitalisation = Share price x Shares outstanding x Free-float factor. Index weight = Company free-float capitalisation / Total free-float capitalisation of the index.
Take a listed engineering group with 100,000,000 shares outstanding trading at $25 a share. Its full market capitalisation is 100,000,000 x $25 = $2,500,000,000. The founding family holds 30,000,000 shares and a state investment fund holds another 10,000,000, so 40,000,000 shares are treated as restricted and the free float is 100,000,000 - 40,000,000 = 60,000,000 shares, a free-float factor of 0.60.
Free-float market capitalisation is therefore 60,000,000 x $25 = $1,500,000,000. If the index that includes this company has a total free-float capitalisation of $30,000,000,000, the company's index weight is $1,500,000,000 / $30,000,000,000 = 5%.
Compare that with the older approach. If the same index were weighted on full market capitalisation and its aggregate full capitalisation were $40,000,000,000, this company's weight would be $2,500,000,000 / $40,000,000,000 = 6.25%. The 1.25 percentage point difference is exactly the part of the company that index investors cannot buy, and it is why free-float weighting produces a more investable benchmark.Case study
Seen in the real world.
Kestrel Pacific Holdings is a fictional listed conglomerate used here as an illustrative example. It had 400,000,000 shares in issue at $12, giving a full market capitalisation of $4,800,000,000, but the founding family held 60% and a long-standing industrial partner held a further 15%, leaving a free float of 25%.
Its free-float capitalisation was therefore $4,800,000,000 x 0.25 = $1,200,000,000, and its weight in the national index was roughly a quarter of what its headline size implied. Management complained that the company was underowned by institutions, and the investor relations team could not explain why coverage from analysts was so thin relative to the group's revenue.
The board's illustrative solution was a phased family sell-down of 20% of the company over two years, taking the free float to 45%. The float factor was raised at two consecutive index reviews, index weight almost doubled, and daily traded volume rose enough for several institutions to take positions they previously considered too illiquid. The company's underlying business had not changed at all; only the shares available to buy had.
Watch out
Common mistakes.
- Treating free-float capitalisation as the company's market value, when the free float figure is an index construction input rather than a valuation.
- Assuming index weight tracks company size, and then being surprised when a very large business with a small float barely registers in the benchmark.
- Ignoring scheduled index reviews, which is how investors get caught out by the mechanical buying or selling that float factor changes create.
Questions
People also ask.
Which shares are excluded from the free float?
Typically founder and family stakes, government holdings, cross-shareholdings, locked employee shares and any shares under a lock-up or transfer restriction.
Why did index providers move away from full market capitalisation weighting?
Because full weighting required tracker funds to buy shares that were not actually for sale, creating distortion and higher tracking error for passive investors.
How often does the free-float factor change?
Providers usually review floats quarterly or semi-annually, with changes announced in advance so that funds can trade on the effective date.
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