Mutual funds are entering Alice and Wonderland: they are being rated as less risky when real risk (as retail investors understand risk) increases. Risk ratings look at the performance in the last 10 years. "Poof" the Great Financial Crisis has ceased to exist. No real bear market in the last 10 years which of course means that bear markets (which on average happen every 3-5 years) have been eliminated by regulatory fiat.
The Globe and Mail highlighted this problem in "Why investors need to be concerned about misleading risk ratings". Investor advocates told regulators years ago that their volatility test was flawed. Now investor advocates and industry experts are raising a warning flag as the problem they highlighted has materialized.
The Canadian investment fund industry is undergoing a mass revision of its risk ratings, making many mutual funds and ETFs appear safer than they actually are, according to some investor advocates.
"This will mislead investors. Advisers themselves are being fooled by the ratings," said Ken Kivenko, a prominent investor-rights advocate. The "flawed" risk-rating framework is drawing Canadian investors, including retirees, into inappropriately risky funds, he said.
"For risk ratings to ... fall for years as market prices keep rising makes no sense," Mr. Hallett said.
"The actual risk of these investments has not gone down. In reality, it's probably gone up, because stocks are trading at historically high valuations, particularly in the United States," said Ermanno Pascutto, executive director at the Canadian Foundation for Advancement of Investor Rights.
What will regulators do? They suggest that retail investors need to learn about volatility and different measures of risk and read the prospectus. Warning: you may need to hire a CFA or lawyer to explain this to you.
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