Market benchmarks like the FTSE 100, the Dax and the Cac40 have been created partly to facilitate trading in futures products and ETFs. But their structures can cause distortions.

One reason is that indices like this are capitalisation-weighted, with rules to allow for flexibility in changing constituents as company share valuations fluctuate. One side effect, for example, has been for indices like this, such as the Footsie, to become dominated by a handful of large companies.

For instance, the top 10 companies in the Footsie currently account for a weighting of close to 47 per cent of the index, while the top five companies account for about 28 per cent of the weighting. The biggest constituent – Royal Dutch Shell – has a capitalisation 10 times that of the 27th largest one and and even larger multiple when compared to those lower down the scale. So index providers have had to tinker with the rules to try and tame these distortions.

One way that has been tried is for weightings of individual companies in the index to be restricted by an adjustment linked to the percentage of their shares that are freely tradeable on the market. So companies with sizeable minority (or even majority) shareholders have their weightings reduced more or less proportionately.

Currently, for instance, companies which have a so-called 'free float' between 50 per cent and 75 per cent of the total have their weighting reduced to 75 per cent of what it would otherwise be if market capitalisation alone was the only criteria. Those with a free float of 40-50 per cent have their weighting reduced to 50 per cent of normal, and so on down the scale.

The free-float adjustment was not always in place. It was implemented by FTSE International in the 2001-02 period after a review a year or two earlier. The free-float adjustment rules and other issues are currently being reviewed to see whether more changes are required to reflect an increasing number of majority-owned large overseas companies emerging as potential index constituents.

As of December 2011 there were, for example, 10 large companies from the former Soviet Union (FSU) listed on the main market in London, of which three – Kazakhmys, Essar Energy and Eurasian Natural Resources – were already FTSE constituents. Most of these companies have a majority of shares tightly held. The review of the rules have been given greater poignancy by the fact that more Russian and FSU companies are applying for main market listings – including Polyus Gold, Polymetal and Evraz – and all are likely to become Footsie constituents under current rules.

In some cases, listing rules have been waived to allow these companies, which are substantial businesses even on the basis of relatively small free floats, to gain a presence in London. Part of the reason for this has been to allow the London market to cement its longstanding place as a market where shares with an international flavour are traded.

It has, however brought complaints from some big investors to the effect that companies with small free floats are prone to governance issues that could lead to the interests of minority shareholders being damaged. Some institutions want the 25 per cent free-float minimum to be more strictly enforced and existing index constituents with a percentage free float below this figure to be allowed to remain, but only if they move towards the 25 per cent over time by diluting majority shareholders' interests in some way.

Another option being investigated is capping the maximum percentage weighting for any single index constituent at 5 per cent. At the moment the top four companies in the index have weightings of more than 5 per cent. Capping these at 5 per cent would lead to the combined weightings of the top 10 companies in the index dropping from 46.5 per cent to 40.5 per cent. FTSE already calculates an index based on this assumption although, in truth, its performance does not vary much from that of the normal index. Capping at, say, 3 per cent might make the index more representative.

A more thoughtful objection to the Footsie as a benchmark is that, because constituents change on a quarterly basis and because the bigger a company's market value the more heft it has in the index's performance, it tends to have a bias towards companies and sectors that are doing well in momentum terms. In the late 1990s, the index came to be dominated by internet and telecoms companies and at other times, mining companies, and banks and financials have also had an important role.

There is no simple answer to the conundrum of the Footsie's representiveness, or lack of it.

Index providers have done their best to counter the more flagrant examples, by using the concept of 'free float'. But while the Footsie undoubtedly reflects the weight of money in the market, it is as well to be aware of its shortcomings. If the top half dozen or dozen big stocks underperform, so will the index and any investment product based on it.

This was written for our sister website, Interactive Investor