More launches of risky funds and greater volatility in recent years underlie a trend toward higher risk ratings. But whatever direction risk ratings are trending, financial advisors’ assessment of fund risk involves a whole lot more than risk rating descriptors.
The Canadian Securities Administrators’ (CSA) risk classification methodology for funds, adopted in 2017, uses standard deviation (volatility) of fund returns over the past 10 years, with a fund’s risk categorized on a five-point scale from “low” to “high.”
Risk ratings trended lower a few years ago as the 2008–09 era was no longer included in the 10-year volatility calculation. More recently, the trend is in the opposite direction. Covid aside, “2024 and 2025 have been the most volatile time periods since the global financial crisis,” said Prerna Mathews, vice-president of ETF product strategy with Mackenzie Investments in Toronto. “We’ve got higher interest rates, inflation shocks, geopolitical uncertainty — all of these are drivers that are pushing return volatility up.”
In the past two years, a minor proportion (77 funds) of all Canada-listed ETFs have had risk rating changes, said Brian Bridger, senior vice-president of analytics and data with Fundata Canada Inc. in Toronto. Still, among these funds, the ratio of increasing risk ratings to decreasing ones is about three to one, he said.
More generally, there seems to be a greater proportion of funds with higher risk ratings, reflecting the types of funds being launched, Bridger said. Higher-risk ETFs typically account for about 15% of launches in a given year but currently account for about 32%. “This year specifically, you’re getting a lot more [launches] of the leveraged ETFs” as well as launches of single-stock ETFs and crypto ETFs, Bridger said.
To the end of September, 308 ETFs have been launched in 2025. Almost a third (104) were leverage/inverse leverage ETFs — a record for the category — and 34 were crypto-asset ETFs, according to data from National Bank Capital Markets.
Also, as the overall number of ETF launches increases — a record 231 new ETFs debuted last year — more proxies or reference indices must be used in the calculation of standard deviation, given new funds don’t have historical performance data. The use of proxies or reference indices is “sometimes why you see funds increase in risk rating after a couple years,” Bridger said. “The initial index … wasn’t a perfect representation of … how [the fund] was actually going to behave.”
Another factor in the trend toward higher risk ratings is that regulators expect fund managers to be conservative, Mathews said. “Many firms are exercising discretion to move funds up a notch — especially when you’re at the cusp of a higher category,” she said.
A manager may also be inclined to increase risk ratings after other funds in the same category have done so. The change signals to advisors that the fund offers similar exposure as others in the category, Mathews said.
Further, dealers can have their own internal ratings, which are often stricter than the standardized methodology, she said.
But regardless of trends in the direction of risk ratings, “standard deviation does not provide a full picture of risk,” Mathews said. For starters, standard deviation is backward looking, and the 10-year time frame “can be a very regime-sensitive view.” (Some industry stakeholders have suggested a bear market should always be included in risk-rating calculations.)
Further, standard deviation “tells us how bumpy the ride is, but it doesn’t actually capture things like liquidity risk or leverage or tail events,” Mathews said. It also doesn’t account for direction — upside or downside volatility.
Her advice to advisors is to conduct thorough due diligence beyond risk ratings. “Look at a product at the underlying level and ensure you fully understand the risk and return you are seeking,” she said.
“You definitely have to look at more than just the risk rating to see how an ETF might actually behave,” Bridger said. “It is very difficult to get an accurate representation of a fund just based on a five-point [risk] scale.”
Fundata reports various metrics related to risk, including a fund’s maximum drawdown. “The actual potential loss is something important that should be looked at,” Bridger said. Market cycle should also be considered. “We are at a point now where the market has done really well,” and investors shouldn’t expect that performance to necessarily persist, he said.
The risk of capital loss is a real investor concern, and putting numbers to market losses — and even recovery times — can help clients better understand risk.
ETF investors also need to consider such factors as how often a fund is traded, its trading volume and the resulting spreads. While spreads won’t be listed in a fund’s MER, they’re “essentially costs to buying and selling, on top of any potential commissions,” Bridger said, and thus influence returns.
Risk ratings “are only one input,” and they “don’t necessarily correspond to a client’s understanding of risk,” said Jason Pereira, a partner with Woodgate Financial Inc. in Toronto. Advisors need to educate clients, “letting them know how things can go wrong and to what degree.” He discusses the risk of the overall portfolio allocation, providing worst-case scenarios based on historical data for different time periods.
Pereira also said advisors should establish a risk profile for a client before making recommendations. Risk ratings aside, when building portfolios, advisors should generally view equities as high risk, bonds as medium risk and cash as low risk, he said. Sector-specific investments, which are subject to secular swings in volatility, should also be considered high risk, he said.
At the manager’s discretion
A compliance review by the Canadian Securities Administrators of 45 fund managers found that between 2018 and 2024, almost two-thirds used discretion to increase or maintain risk ratings (rules prevent the use of discretion to lower risk ratings). Common reasons for the use of discretion were that the methodology placed the fund on the verge of a higher risk category or moved it to a lower one (in the case of the manager maintaining a rating).
The review helped inform CSA guidance, published this year, on managers’ reasonable use of discretion. “In particular, [managers] should consider the standard deviation calculation and determine whether the investment risk level is appropriate given the type of fund, the types of investment strategies used, the asset class, general market performance expectations and abnormal return periods,” the guidance says.
This article appears in the November 2025 issue of Investment Executive. Read the digital edition or read the articles online.