Office of Financial Research ("OFR") researchers questioned the utility of SEC Form PF. In a published working paper, the researchers stated that they found "significant 'wiggle room" in the application of the Form as a risk-management instrument. It made several recommendations for improvements.
The authors generated a range of simulated portfolios and equity options in order to assess the precision of Form PF as a measurement tool for risk exposure. They also considered the effect of basic options strategies on certain risks that Form PF is intended to measure.
Specifically, they examined the "cross-sectional distributions of standard risk and performance measures of simulated portfolios" in order to determine the "dispersion of the actual portfolio risk and performance of funds with identical presentation on Form PF," with particular attention to value-at-risk ("VaR") portfolios. Through these "cross-sectional distributions," the authors found "significant and widespread dispersion in risk and performance among both VaR-unconstrained and VaR-constrained portfolios" despite their identical presentation on Form PF. The authors concluded that the inclusion of options has a "significant impact" on actual portfolio risks. The range of permitted actual risk is especially large for portfolios that include options but do not report VaR on Form PF.
The authors recommended that the SEC:
rearrange the strata of characteristics that are utilized by Form PF to represent complex portfolios or, alternatively, capture additional characteristics on Form PF in order to constrain the range of possible risk profiles more tightly; and
revise Form PF to require, as does SEC Form 13F, position-level details about portfolio holdings.
The paper's publication is timely in light of the new provisions in Section 404 of the Dodd-Frank Act financial reform law that enable enhanced regulatory reporting on private funds seeking to protect investors and assess systemic risk.
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