Valuing a portfolio through a transition

We received an interesting question from a client, which seem appropriate to discuss here:

We have an issue where we are going back and forth with our custodian regarding the proper treatment for a transition:

• Manager B is scheduled to receive assets from Manager A at the end of day on January 4
• on January 4, the custodian transfers the securities from Manager A based on January 3 prices (e.g. $5.20Million)
• the securities are valued at end of day January 4 (e.g., at $5.10Million)
• the result is an unrealized loss on the securities on January 4

What prices should be used to value these securities? Instructions were given to have the securities transfer at the end of the day on January 4, so the transfer amount and portfolio value were the same and no gains/losses occurred. Under the scenario above, there is a loss that we believe should not occur.

The answer should be based on "discretion." That is, at what point does Manager B have discretion over the assets. This doesn't occur until the end of day on the 4th, and so to use the pricing at the start of the day (i.e., from the end of the prior day) would be unfair and inappropriate, since the manager cannot act on these shares until the transfer occurs.

What about Manager A? Here, we would expect the valuation to end, at least from a performance standpoint, at the point they no longer have discretion. This may have been a few days or even a few weeks or longer before the transfer occurs. From a GIPS(R) (Global Investment Performance Standards) perspective, we'd expect the portfolio to have been pulled out once the manager lost discretion.

And so, we would expect to see a "gap," where no one has discretion.

Manager A was probably reporting to the client through  December, and will probably provide a final report in January, which will reflect the transfer. We would expect to see it priced at the close of business on the 4th, though this may not occur.

The key point here, I think, is that for Manager B, control begins at close of  business on the 4th, so that's when the pricing should occur.