1. Retail Research 1
Midcap Category – Riskier than largecaps but outperform over long run June 10, 2013
In this note, we state some of the findings of a study carried out on Equity Diversified mutual fund schemes by comparing the risk and
returns generated by the Largecap and Midcap schemes.
Key findings:
1. The risk of Midcaps, as measured by annual Standard Deviation of returns, is higher than the largecaps at any point of time.
2. Analysts belonging to the fund industry follow different calculation methodologies to arrive at Standard Deviation figures (to
measure the risk of a scheme or index). In other words, the returns data points that are used for calculating Standard
Deviation vary among analysts.
3. The Annualized Standard Deviation calculated based on daily rolling returns showed that largecaps carry higher risk than
midcap while the calculation based on the data points like 1 month, 3 month, 6 month or 1 year rolling returns showed that
midcaps carry higher risk than largecap.
4. The lower risk shown by midcaps over largecaps as measured from daily returns (see the chart 1) is probably due to circuit
filters that applicable for midcap stocks coupled with wider movements of largecap stocks on the back of concentrated
constituents in the barometers and lesser liquidity in Midcaps (compared to largecaps) resulting in spreading of sales and buys
over a period of time. On the other hand, the calculations that are based on 1 month, 3 month, 6 month and 1 year returns
display the true picture of high risky profile of midcap stocks thus proving the higher volatile nature than largecap counterparts
(see the chart 2,3,4 & 5).
5. This is the trend seen not only between Largecap and Midcap mutual fund categories but also between the CNX Nifty and
CNX Midcap indices.
6. Between Sensex and Nifty, Sensex carries marginally higher risk than Nifty given its concentrated stock constitution (30 stocks
vs 50 stocks). The CNX 500 carries higher risk than Nifty but lower risk than CNX Midcap.
7. As far as the returns part is concerned, the midcap funds outperformed largecap funds over the longer duration say for the
investing periods of nine years and more (See the chart 7). They underperformed Largecaps in the short and medium term.
Meanwhile, as far as SIP investments are concerned, the Midcap funds outperformed largecap schemes for the investing
periods of 5 years and more (see the chart 8).
In mutual funds, one of the main risks pertain to volatility. Volatility is the fluctuation of the NAV over the defined period. Standard
deviation is used to measure the volatility of the schemes. It reflects the consistency of performance. Standard Deviation gives you a
good idea if you can tolerate an investment’s ups and downs. The higher this number, the more likely you are to experience dramatic
moves in either direction. Example: Standard deviation of 10 means an investment averaging 10% annual returns has historically (for
about 68% of the sample size) ranged from –0% to +20% each year. In a nutshell, a higher standard deviation implies greater volatility
or risk.
For our study, we have considered last 10 years data say from May 2003 to May 2013 to measure the risk in the indices. To measure
the risk in the mutual fund categories, we considered last 5 years data (from May 2008 to May 2013). We calculated Annualized
Standard Deviation in five different ways using daily rolling return, 1 month, 3 month, 6 month and 1 year rolling returns. The findings
are charted below.
Midcaps carry higher risk than Largecaps:
The following charts compare the risks generated by Sensex, Nifty, CNX Midcap and CNX 500 over the last ten years period (from
2003 to 2013). The Chart 1 shows the Annualized Standard Deviation data that are calculated from indices’ daily rolling returns for last
10 years period. Likewise Chart 2 shows the Annualized Standard Deviation data which are calculated from one month rolling returns of
the indices for last 10 years period.
From the following charts one can observe that the Sensex and Nifty showed higher risk than CNX Midcap in the chart 1, while the CNX
Midcap show higher risk than Sensex and Nifty in the rest of the charts (charts 2,3,4 and 5).
In the chart 1, the largecap indices – Sensex and Nifty saw carrying higher risk compared to CNX Midcap which was mainly attributable
to applicable circuit filters to the midcap stocks in the exchanges coupled with the wide movements of largecap stocks on the back of
concentrated constituents in the respective barometers and lesser liquidity in Midcaps (compared to largecaps) resulting in spreading of
sales and buys over a period of time.
Hence, higher volatility in the midcap stocks results in carrying higher risk than largecap. The same is shown in the charts 2,3,4,and 5.

2. Retail Research 2
Chart 1: Risk as measured by Annualized SD based on Daily Rolling Returns. (Largecap seem to be carrying higher risk)
Annualized Standard Deviation based on Daily Rolling Returns for last 10 years period
34
26 25 25
0
5
10
15
20
25
30
35
40
Sensex Nifty CNX Midcap CNX 500
Chart 2: Risk as measured by Annualized SD based on 1 month Rolling Returns. (Midcap witnessed carrying higher risk)
Annualized Standard Deviation based on 1 month Rolling Returns for last 10 years period
27 27
31
28
0
5
10
15
20
25
30
35
40
Sensex Nifty CNX Midcap CNX 500
Chart 3: Risk as measured by Annualized SD based on 3 month Rolling Returns. (Midcap witnessed carrying higher risk)
Annualized Standard Deviation based on 3 month Rolling Returns for last 10 years period
39 38
45
41
0
10
20
30
40
50
60
Sensex Nifty CNX Midcap CNX 500
Chart 4: Risk as measured by Annualized SD based on 6 month Rolling Returns. (Midcap witnessed carrying higher risk)
Annualized Standard Deviation based on 6 month Rolling Returns for last 10 years period
33 32
39
35
0
10
20
30
40
50
Sensex Nifty CNX Midcap CNX 500

3. Retail Research 3
Chart 5: Risk as measured by Annualized SD based on 1 Year Rolling Returns. (Midcap witnessed carrying higher risk)
Annualized Standard Deviation based on 1 Year Rolling Returns for last 10 years period
31
29
39
32
0
15
30
45
Sensex Nifty CNX Midcap CNX 500
Another main reason for higher risk shown by Sensex and Nifty in the Chart 1 is the concentrated constituents in the respective
barometers. The number of constituents in the Sensex and Nifty are 30 and 50 while the number of constituents in the CNX Midcap is
100. Such diversification in number of constituents plays important role in mitigating the volatility. In other words, the top 5 constituents
have 40% and 33% weight in Sensex and Nifty while in CNX Midcap these have 17% weight in the index. It is worth noting that sector
concentration also plays considerable role in this case.
Table 1. Concentration analysis:
Particular Sensex Nifty CNX Midcap CNX 500
Largecap
MF category
Midcap MF
category
Top 5 stocks / median Top 5 holding 39.96% 33.31% 17.00% 21.35% 31.26% 21.82%
Top 10 stocks / median Top 10 holding 62.04% 51.71% 28.29% 33.15% 49.92% 37.31%
No. of constituents / Median no. of constituents 30 50 100 500 36 45
Note: Indices data are based on June 04, 2013. Mutual funds data are based on last five year periods.
Risk in Mutual Fund largecap and Midcap categories:
The same trend witnessed in mutual fund categories also (see the chart displayed below). The midcap category showed lower risk if the
Standard Deviation is calculated from Daily returns while the midcap funds showed higher risk if the calculation is based on monthly
and other periodicity.
To conclude, the midcap categories carry higher risk than largecap categories.
Chart 6. Risk in Largecap and midcap categories:
23
26
29
33
29
22
30
37
41
40
0
5
10
15
20
25
30
35
40
45
Ann SD based on daily rolling returns Ann SD based on 1 Month rolling
returns
Ann SD based on 3 Month rolling
returns
Ann SD based on 6 Month rolling
returns
Ann SD based on 1 y ear rolling
returns
Largecap Category Midcap Category
Returns:
As far as the returns generated by the largecap and midcap schemes are concerned, considering the rolling returns the different time
frames (rolling return calculated for the scheme from the last 10 year data), largecap schemes witnessed outperformance for 7 year
periods while the midcaps saw outperformance for 9 years and above. In the case of SIP investments, midcap schemes witnessed
outperformance for the periods of five years and above.

4. Retail Research 4
From the above points one can conclude that Investments through staggered modes such as SIP is highly advisable in midcap
schemes given their high risk profile nature. A small exposure to SIP in midcap scheme can be taken by any kind of investors and run
for minimum five years period. However, the investors have to be careful on choosing funds for the investments. Periodical review of
portfolio (at least twice in a year) can help to reshuffle out of persistent laggards.
Chart 7. Performance of Largecap and midcap schemes: (Rolling Returns calculated from last ten year data)
0
5
10
15
20
25
30
1 Year 2 Years 3 Years 5 Years 7 Years 9 Years 10 Years 12 Years
Large cap Mid cap
Chart 8. SIP Returns (XIIR):
0
5
10
15
20
25
1 Year SIP 2 Year SIP 3 Year SIP 5 Year SIP 7 Year SIP 9 Year SIP 10 Year SIP 12 Year SIP 13 Year SIP
Largecap MFcategory Midcap MFcategory
The schemes within the category vary in different aspects which may also impact the risk and return of the overall category. Some of
the factors that includes such as investment objective, benchmark they track, turnover ratio, expenses ratio and so on.
Midcap stocks are high beta stocks and respond faster than large caps to the market information. They have higher return potential
compared to large caps. They have better growth prospects due to presence in a new segment/ area that is growing at a faster pace.
They have ability to gain share due to new technology, better product / service etc. They have smaller base of revenues and profits;
hence growth rates can be larger. Floating stock may be limited; hence small demand for stocks results in more than proportional rise in
prices. There is a room for P/E multiples to expand if the company transitions from a small / mid cap to large cap, etc.
As far as large cap companies are concerned, the growth is lower in comparison to the period when they were mid cap companies as
they are there in the relatively early stages of their business life cycles and their base was smaller. Midcap stocks also offer investors
opportunities to capitalize on merger and acquisition activity as some attractive businesses have the potential to be acquired by larger
firms. Small and Midcap companies offer higher return potential than large cap companies and also carry higher risk than large cap
companies, particularly over the short and medium term.
This report is in continuation with our earlier report (Equity markets nearing a bottom - Can one start SIP in midcap funds?), which also
elaborated on the lower risk and higher return nature of mid cap mutual fund schemes over the large caps counterparts.

5. Retail Research 5
Analyst: Dhuraivel Gunasekaran
RETAIL RESEARCH Fax: (022) 3075 3435
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Greaves, Kanjurmarg (East), Mumbai 400 042 Fax: (022) 30753435 Website: www.hdfcsec.com
Disclaimer: Mutual Funds investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared
by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made
available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is
from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to
time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or
other services for, any company mentioned in this document. This report is intended for non-Institutional Clients.