A total of 286 funds had risk rating changes in 2017. This amounts to 10%
of all funds that were active at the end of 2016 and is a fourfold increase
year over year. Ratings decreases (216), have far outpaced ratings
increases (70). Granted, while it has not quite been the 97% clip that I
said was possible, a 3-to-1 ratio is still awfully high. And as I
mentioned, the bulk of the changes would likely start to occur in late
2018. As we wait for the rest of the dominos to fall, let’s take a look at
some of the changes thus far.
I have intentionally left out the actual fund names, the main reason being
that this article only covers funds that have changed ratings, and it would
be unfair to call out these funds while not also mentioning the funds with
similar risk ratings that did not necessarily have a change in 2017.
A total of 70 funds increased their risk rating in 2017. Eight of these
funds increased their prospectus risk by two rating levels, and in all of
these cases, the funds moved to “High” risk from “Medium.” Three of these
funds are commodity funds that hold either gold or silver bullion. Moving
the risk rating up for these funds is somewhat obvious considering one of
these funds (the only one with a 10-year history) has a 10-year annualized
standard deviation (SD) of over 25%. Other notables in the group include a
Natural Resource fund, a Global Equity fund with a 10-year SD of over 20%,
and a U.S. Equity fund with a 7-year SD of 33%!
Of the remaining 62 funds that increased their prospectus risk rating by
one level, the category that stands out is U.S. Equity. Nineteen funds had
risk rating increases, with most ratings moving to “Medium to High” from “Medium.” While there is one fund that seems to have voluntarily
increased its risk rating, most have done so because their 10-year SD is
slightly over the “Medium to High” threshold of 16%. Yet most have a 9-year
SD that is below the threshold. Therefore, if low volatility persists
through 2018, many of these funds will be eligible to revert back to a
“Medium” risk rating, which is something to keep an eye on later this year.
There were 216 funds that decreased their risk rating in 2017, and three of
these managed to lower their rating by two levels. These include a Real
Estate Equity fund, Emerging Markets Equity fund, and a U.S. Equity fund,
and in all cases the rating changed to “Medium” from “High.”
The Emerging Markets Equity fund rating change is curious, considering even
the last installment of IFIC’s
Voluntary Guidelines for Fund Managers Regarding Fund Volatility Risk
Classification (June 2017), suggested funds in this category be assigned a risk rating of “Medium to
High.” Given that this fund only debuted in 2016, there is no way to
validate the 10-year SD, and while the company attributes the change to the
CSA methodology , there is no mention of the proxy used to backfill the
10-year history. However, if we use a standard benchmark such as the
S&P DJ Emerging Markets TR Index (C$) or even the category average, the
10-year SD would indicate “Medium to High” risk.
The U.S. Equity fund is also interesting, as the fund is highly
concentrated in the tech sector. The top four holdings account for close to
30% of the portfolio and include Facebook, Apple, Alphabet (Google), and
Microsoft. And while the 10-year SD is technically under the “Medium to
High” threshold (albeit just barely), the 20-year SD for this fund is over
22% and during the early 2000s tech bubble, suffered a maximum drawdown of
83%! Hardly the type of loss a “medium-risk” investor would expect.
Dubious rating changes
That leaves us with 213 funds that lowered their rating by just one level.
There are examples from across almost every category, but there are some
clear trends. There was a disproportionately large number of Canadian and
Global Fixed Income Balanced funds that lowered their ratings. And in all
cases, these funds moved down to “Low” risk, which is below the ratings
suggested by the aforementioned IFIC methodology. Emerging Markets Equity
and High Yield Fixed Income funds also account for a high percentage of the
Overall, there were 32 equity funds that lowered their rating down to “Low
to Medium,” a rating that the IFIC methodology has never suggested for any
equity category. With markets at all-time highs and valuations stretched,
do we really think equities are less risky than ever?
Now for a few of the more dubious changes. A Greater China Equity fund
lowered its risk rating to “Medium to High” from “High” and cited the new
CSA rules as justification for the change. However, its 10-year SD is over
22%, a historically low value for this fund and still well above the
threshold for a “High” rating. Similarly, a Global Equity fund moved to
“Low to Medium” from “Medium” despite having a SD in excess of the 11%
There are many other examples of risk rating that do not meet the eyeball
test, however much the persistently low volatility in the market has
depressed SD values. The big problem is that the longer this goes on, the
more irrelevant the risk ratings become.
Brian Bridger, CFA, FRM, is Vice President, Analytics & Data at Fundata Canada Inc. and is a
member of the
Canadian Investment Funds Standards Committee.
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