Free-float NZSE40 model rewards widely held shares

By Stephen Wright, Dow Jones Newswires

Friday 30th August 2002

Share turnover will get a temporary boost and underperforming stocks may shine while market darlings wither - but only until investment fundamentals reassert themselves - if the Stock Exchange adopts a free-float model for its benchmark index.

A free-float model doesn't count blocks of shares that aren't easily traded, slashing the index weighting of tightly held companies and forcing funds that track the index to sell those stocks. The reverse is that relatively widely held stocks will increase their weighting and be much sought after, squeezing their prices higher.

Somewhat perversely, financial services group Tower, which has been blighted by a poorly performing share price, could be one of the beneficiaries while retailer Briscoes, a market darling, would be hit as it's 75% owned by Rod Duke.

Air New Zealand would be one of the biggest casualties as 90% of its shares are controlled by major shareholders. A free float would reduce its recognised capitalisation to less than $200 million compared with about $1.9 billion at present.

The fact a free-float weighting gives investors a better picture of a company's share register, allowing for better-quality investment decisions, is regarded as its main advantage over market-capitalisation weighting. As a fundamental change to index construction it also picks winners and losers, albeit temporarily, creating trading opportunities for those bold enough to second guess the outcomes.

The Morgan Stanley Capital Index provides one model. Free float is defined as total shares on issue excluding shares held by strategic investors such as governments, corporations, controlling shareholders and management, and shares subject to foreign ownership restrictions.

Under MSCI's rules, a stock's estimated free float is rounded up to the closest 5% if 15% or more of its shares are freely tradable. For example, a stock with a free float of 23.2% of its issued shares will be included in the index at 25% of its total market capitalisation.

Ports of Auckland, which has a single shareholder controlling 80% of its shares, may face a similar scenario as Air New Zealand. Other potential losers include the market's second biggest stock by capitalisation, Carter Holt Harvey, which is half-owned by International Paper; Contact Energy, 51% owned by Edison Mission Energy; and Natural Gas Corp, 64% owned by Australian Gas Light. Sky Network TV and its 66.25% owner INL are also high on the casualty list.

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