Exchange traded funds typically try to follow a benchmark index. However, investors should be aware that the underlying indices can implement different methodologies when accessing various market segments.
For instance, some markets may only have a selection of large company shares available to the public and the index would have to make the distinction between treating the company’s market capitalization based on total value or just the value of shares available, writes Adam Zoll for Morningstar.
Consequently, investors can find that some ETFs track “float-adjusted” indices where the so-called float component refers to the percentage of shares that are publicly traded – if a company issues 10 million shares but only 9 million makes it to the public, the company is said to have a float of 90%. The shares that are not available to the public are also excluded from the ETFs and would not be included when determining a company’s weight in a float-adjusted index. [Institutions Increasing Smart Beta Usage]
However, the company’s full market capitalization, which includes both floating and non-floating shares, is used to determine its inclusion into an index.
The float-adjusted component can also be used for bond indices. For example, Vanguard has switched to float-adjusted versions of the indices for its bond mutual funds and ETFs after the Federal Reserve began its bond purchasing program, which essentially removed a portion of the fixed-income market from public trading.