A common challenge with asset managers is how to deal with what might be termed “orphan income”: income that arrives after the asset that produced it has departed the portfolio. This often happens when we sell a stock position after it has gone ex (i.e., any purchasers of the stock after this date will not be entitled to the dividend, but the sellers will be, even though they sold their shares) but before the dividend has been received. It is not typical with fixed income securities, because when a bond is sold, the purchaser typically pays the seller any accrued income.
Case in point: you own stock that goes ex dividend on the 5th of the month. You sell it on the 6th, and the pay date is the 15th. When the money arrives, there is no asset to tie it to. If you measure performance on that stock, you find yourself going from a zero market value to the value of the dividend, which can be a bit messy.
Option #1: shift the date you received the money (the 15th) back to the date you sold it (the 6th). That makes everything work out fine, right? This would not be appropriate, since you shouldn’t adjust the pay date, as this is altering the true accounting that occurred. This can be especially problematic at year-end, as you would receive income in the year prior to its actual receipt.
Option #2: carry an accrual until pay date. THIS makes sense, does it not? Ideally you’re carrying an accrual, anyway, once the stock went “ex.” But if you didn’t, create an accrual in cases like this. This way, you will derive the correct return and not mess with the accounting.
Have different thoughts? Chime in!