S&P to assess fund volatility

Standard & Poor’s has announced the introduction of “sensitivity ratings” in an effort to help investors determine how much a fund’s unit price or total return may shift as market conditions change.

“We have developed these ratings because currently there is no universally accepted measurement of a fund’s volatility that can be consistently applied to funds with different types of assets,” said Standard & Poor’s fund analyst Joel Friedman.

Although investors have long compared the performance of stock funds with well-known benchmarks such as the TSX and the S&P 500, existing indices for bonds, fixed income securities funds, alternative investments and other non-equity assets do not have the same level of market acceptance, S&P notes.

“As new fund products have increased over the past few years, a risk measure that cuts across asset types and identifies volatility at its core, will offer greater transparency for everyone in the market,” adds S&P managing director Gary Arne.

The rating categories, which are anchored to a benchmark, enable investors to decide how much potential exposure to risk they want to experience, the ratings agency says. These ratings range from the most stable, or those with extremely low sensitivity to changing market conditions, to the most volatile funds, or those with extremely high sensitivity.

“Sensitivity ratings will make it easier for investors to discern the level of risk in any given fund,” S&P says. “This is especially important as market volatility is an increasingly important consideration for investors, who can see the value of their investment devastated by sudden, unexpected loss.”

For instance, a fixed income fund’s net asset value can rise or fall because of changes in interest or foreign exchange rates, S&P explains. “And clearly, the performance of an actively-managed fund depends on the skill of its manager.

“Two funds might have similar marketing descriptions but may perform far differently, depending on the choice each manager makes.”

The main quantitative driver in the sensitivity rating is a fund’s Value At Risk (VAR), relative to a risk-free one-year benchmark, the Scotia one-year Canadian T-bill index. Other benchmarks include the Scotia short term index, the Scotia medium-term index, the Scotia long-term index and the TSX.

Based on 2005 data, there is a 98% probability that a $10,000 investment in the Scotia medium term index would have gained as much as $52 dollars in one day or lost as much as $47 dollars in one day. The risk-free benchmark would gain as much as $9 or lose as much as $10 during the same period.

The sensitivity ratings use other data, such as relative volatility, beta and tracking error. In addition, S&P analysts will meet with fund managers prior to setting initial ratings and once a year after that.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com