Free float methodology in index calculation aids both active and passive investment strategies. Active managers are able to compare their portfolio return vis-à-vis the investable index and at the same time passive fund managers are able to offer low tracking error by introducing passive funds such as index funds, exchange traded funds linked to investable indices calculated based on free-float methodology.
This improves market coverage and sector coverage of the index. For example, under a full-market capitalization methodology, companies with large market capitalization and low free-float cannot generally be included in the Index because they tend to distort the index by having an undue influence on the index movement. However, under the free-float Methodology, since only the free-float market capitalization of each company is considered for index calculation, it becomes possible to include such closely held companies in the index while at the same time preventing their undue influence on the index movement. – Globally, the free-float Methodology of index construction is considered to be an industry best practice and all major index providers like MSCI, FTSE, S&P and STOXX have adopted the same.