Fund Facts: Focus on risk

The initiative aims to respond to feedback that the CSA has received calling for “a single, mandated methodology for fund managers – to improve consistency and comparability of Fund Facts across mutual funds,” says Rhonda Goldberg, director of the Ontario Securities Commission’s (OSC) investment funds branch.

Investor advocates have long complained that the CSA should do more to ensure that fund portfolio managers’ risk disclosure is accurate and comparable. At various stages throughout the Fund Facts policy-development process, there have been complaints about these risk ratings, including that: firms aren’t disclosing the methodology they use to label their funds’ riskiness; most firms are using a methodology developed by the Investment Funds Institute of Canada (IFIC) rather than a method that has been prescribed by regulators; and the result is insufficient disclosure, in that funds’ risk classifications end up being inconsistent and inadequate.

In 2011, Toronto-based advocacy group the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) wrote to both the CSA and the OSC to complain that some fund companies were not complying with their disclosure obligations, particularly the risk classification. FAIR Canada’s letter argued at the time that firms were “withhold[ing] essential information from investors, preventing them from understanding the level of risk provided in a fund’s prospectus or set out in Fund Facts. How a [portfolio] manager determines the level of risk of a mutual fund is a key piece of information that investors need.”

Critics also have complained about firms’ use of the IFIC methodology itself, arguing that it may not properly capture a fund’s actual riskiness. Instead, investor advocates have proposed that the CSA prescribe a standardized approach to labelling risk, such as the methodology developed by the Committee of European Securities Regulators to ensure that these labels capture risk in a way that’s consistent and meaningful to investors.

In addition, investor advocates have recommended that regulators bolster investors’ understanding of risk by requiring firms both to disclose a fund’s worst monthly, quarterly, or annual loss in the previous 10 years; and to clarify the connection between investor suitability and the risk classification levels used in Fund Facts.

In response, the CSA has acknowledged investor advocates’ concerns and promised to look at the issue. To date, however, the regulator has dealt with those complaints primarily by tweaking the language in the Fund Facts documents, requiring firms to use stronger warning language about the risks of investing in mutual funds and adding an explanation of the risk scales used in the disclosure.

Now, the CSA is working to come up with a prescribed methodology as well – although the regulator is not yet committed to the idea that it must impose a common methodology on firms. Goldberg indicates that the CSA’s proposal will ask whether it’s necessary for the CSA’s member regulators to mandate a methodology.

In addition, Goldberg notes, the regulators are “generally satisfied with the level of comparability amongst risk ratings” that they have seen firms use in their Fund Facts documents.

That said, the regulators have uncovered problems with the way firms make these risk ratings. In early 2012, the OSC reported that it had examined the risk ratings that funds were disclosing through Fund Facts documents and, as a result, six funds with $1.3 billion in assets under management were required to revise their risk ratings to higher-risk levels.

These funds also had to restate their disclosure (in both Fund Facts and their simplified prospectuses) and inform investors of the change in the risk rating because the regulator declared that it considers changes to a mutual fund’s risk level to be a “material change” under securities legislation.

The OSC indicates that it continues to do such reviews periodically, but doesn’t have any updated numbers on funds that have had to reclassify their riskiness as a consequence of these reviews.

In the meantime, both investor advocates and the mutual fund sector will have to wait to see what the CSA comes up with regarding a standardized methodology.

“We will participate in the discussions around whatever proposals the CSA issues,” says Joanne De Laurentiis, IFIC’s president and CEO. As for IFIC’s own, widely used approach, she adds: “It’s premature at this point for us to consider any changes to the IFIC risk methodology.”

The CSA doesn’t have much time if it hopes to introduce a standardized methodology before Fund Facts documents officially replace prospectuses as the primary disclosure that investors receive. As of next June, fund companies will be required to deliver the Fund Facts documents – in place of the traditional prospectus, which will remain available upon request – when an investor buys a unit of a fund.

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