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CSA Mutual Fund Risk Classification Methodology
Letter Summary:
While standard deviation is an informative measure, it is not a complete measure of risk as has been highlighted above, and can mask risks that arise as a result of the complexity of an investment product. As an illustrative example, a short-term fixed income mutual fund or ETF could have very low historical volatility over the measurement period in question, but be quite risky as a result
of the complexity of the fund’s underlying investments, some of which could have very asymmetric risk profiles in the event of a credit event, liquidity issues, or an interest rate shock. The risk rating of the fund, based on standard deviation, would have given the investor no insight into the asymmetric risk profile and complexity of the fund’s investments. The Journal of Finance has recently published a paper [A Risk and Complexity Rating Framework for Investment Products] (Koh et al.) discussing a complexity rating framework, which would help inform and augment traditional risk ratings. The paper describes other vectors that could be considered for risk measurement and required mutual fund and ETF disclosures by the CSA in future projects. The CAC would be happy to engage with interested CSA working group members on this point for a more detailed dialogue in future.
Overview of the Council’s Comments:
The CSA we support efforts to modernize securities legislation and rules in Ontario and were pleased to see that a number of recommendations made by the Taskforce have been addressed. While we appreciate the platform approach taken by the Consultation Draft and the myriad proposals embedded in the draft Act, we believe that additional investor-friendly defining principles for the Act, such as an expanded legislative best interest standard to registrants with discretionary authority over client assets, would make the proposed Act worth the immense prospective effort of implementation for capital markets participants, investors, and regulators