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.
Lofchie Comment: A comment published in 2013 in the Guide to Hedge Fund Regulation captured the prevailing view of Form PF at that time.
[M]any of the questions in Form PF are horrendously written with the result that it is not entirely clear that the Form is even getting at useful information. Even if the information might be useful, funds will inevitably answer the questions in quite different ways, making the information far less useful than it might have been if the Form were better drafted. The questions that are the most poorly designed are the ones that might in theory be the most important; i.e., the questions about leverage and borrowing by hedge funds. These questions are so poorly written that it is sometimes hard to know even what information the authors of the Form intended to collect or even how much they understood about leverage and collateral.
Three years later, researchers at the OFR engaged in a complicated study of options with “cross-sectional” data and determined that Form PF is useless. Any sophisticated professional who works in this area could tell by looking that the questions on the form never had value.