US-Listed ETFs Sorted by Asset Class and Year-to-Date Return

Figure 2
The Float Effect
COUNTRY
UNADJUSTED
MKT CAP
United States 29.6% 42.3% 41.3%
Japan 7.0% 7.7% 7.2%
China 6.9% 2.3% 2.5%
United Kingdom 6.6% 8.4% 8.2%
Hong Kong 4.8% 1.3% 1.4%
Canada 4.1% 4.6% 4.1%
France 3.6% 3.9% 4.5%
India 2.8% 1.0% 1.3%
Brazil 2.8% 1.9% 2.3%
Germany 3.1% 3.4% 3.5%
Australia 2.7% 3.4% 3.4%
Switzerland 2.5% 3.3% 3.0%
Source: Bloomberg. Data as of June 13, 2011.
and 10 percent into SMALL.
That’s the way the first market-capweighted
indexes were built.
But during the 1980s and 1990s, as
money started to flow into passive index
strategies, indexers realized something:
This perfect representation of
the market wouldn’t work in the long
run because the market and stock ownership
structures are complex.
Specifically, while a company like BIG
may have had 900 shares outstanding,
not all of those are actually available
for sale. Some are held by corporate
insiders who can’t sell due to lockup
requirements; others are held by other
companies who won’t sell because it’s a
strategic investment. Let’s imagine, for
the sake of argument, that only 10 percent
of the shares are available—just 90
shares, worth $900. What happens if an
investor wants to put $2,000 to work in
this index? There’s nowhere for it to go.
As Lori Richards, Benchmark Business
managing director at Russell Investments,
explained, “Indexes should
be representative of the opportunity
set available to managers.”
ISHARES ACWI
VANGUARD
TOTAL WORLD
David Blitzer, managing director
and chairman of the Index Committee
at S&P Indices, pointed out that “the
index should be the same as if you calculated
a portfolio representing all the
shares and all the stocks in the market.
And if the founder of some company
wasn’t going to sell his shares no matter
what happened, then his shares aren’t
really in the market, so they ought to
be adjusted out.”
Blitzer explained, “If I included a
U.S. company with a 12 percent float
in the S&P 500 [at full weight], and the
indexers followed suit, all the shares
would be owned by the indexers.” The
share prices would be bid up by investors,
distorting and overstating the actual
value of the stock.
Going back to our theoretical example,
if 800 shares of BIG’s stock are
locked up due to legal restrictions, only
100 shares are truly available for trading.
Because an indexer adjusting for
float only considers the shares available
for trading when building a benchmark,
the resulting weightings in the index
would be 50 percent BIG and 50 percent
SMALL, dramatically different from
what the unadjusted weightings would
be. And any money invested in the index
would stream in cleanly and efficiently.
According to Blitzer, “The S&P 500
traditionally was not float adjusted.”
However, the index excluded entirely
any stock that does not have 50 percent
in public float, thereby reducing
liquidity concerns.
Essentially, no indexes were adjusted
for float until fairly recently. In 1984, Russell
Indexes launched the Russell 1000
and Russell 2000 indexes, the first U.S.
indexes float adjusted from inception. A
few years later, in 1989, the predecessor
to what is currently the S&P Global Broad
Market Index Family was launched; its
methodology included rules for adjusting
the float of the constituents and
made additional adjustments for restrictions
on foreign holdings.
That basically opened the floodgates,
setting an industry standard for
cap-weighted indexes that is followed
by every major index provider.
“[Float adjustment] has definitely
become the industry standard practice.
I don’t know of any cap-weighted index
that’s not float adjusted,” Blitzer said.
Differing Opinions
But should it be standard practice?
Little consensus exists about the
different methods of float adjustment.
Some adjustments address legal restrictions
on the trading of shares such as
IPO lockups and foreign holding restrictions.
Other adjustments of a more
subjective nature are made to take into
account holdings by individuals or organizations
that are not expected to
sell their stakes in the near future. According
to Russell’s Richards, the three
most important factors are beneficial
owners, such as officers or directors of
a company holding blocks of shares;
cross-ownership, which occurs when
companies own shares in other companies;
and IPO lockups.
Real-World Implications
The decision whether or not to make
float adjustments has far-reaching
global implications for indexers. How-
10 ETFR • July 2011