Thomas Herzfeld was back from his morning jog, having toast and coffee, when his son, Erik, called with the big news. President Barack Obama had just announced that the U.S. is restoring diplomatic relations with Cuba and loosening economic and trade restrictions after a decades-long embargo. For the 69-year-old Herzfeld, it was good tidings the week before Christmas.
Two decades ago Herzfeld started a closed-end mutual fund, the Herzfeld Caribbean Basin Fund (ticker: CUBA), that has since invested in companies he expects to benefit from a loosening of economic sanctions against Cuba. Its diverse holdings include Panama City–based airline Copa Holdings; Coca-Cola FEMSA, the Mexico City–based bottling giant; banana grower Chiquita Brands International of Charlotte, North Carolina; Miami-based cruise lines Carnival Corp. and Norwegian Cruise Line Holdings; as well as banks like Bancolombia of Medellín, Colombia, and Hato Rey, Puerto Rico–based Popular.
“We were well prepared,” says Herzfeld, whose investment firm, Thomas J. Herzfeld Advisors, is headquartered in Miami Beach. “Earlier in the year we decided this was the year that the embargo would end.” The fund’s June 30 annual report says as much, noting a roster of power brokers — including former U.S. secretary of State Hillary Clinton — publicly in favor of loosening sanctions and the changing attitudes of Cuban-Americans, who are less supportive of the embargo than they once were.
On the news — which included a concurrent speech by Cuban President Raúl Castro — shares of the Caribbean Basin Fund spiked, rising to an intraday high of $14.97 by December 22, up from $7.25 on the morning of December 17, the day of the announcements, a gain of 106.5 percent. Closed-end funds, unlike their more common open-ended counterparts, issue a fixed number of shares and so can trade above or below their net asset value. The Herzfeld Caribbean Basin Fund had traded most of the year at a discount of more than 10 percent to its NAV, according to data compiled by Bloomberg. By December 22 its shares were trading at a premium of more than 75 percent, giving the fund a market capitalization of more than $80 million. Although the fund has since retreated from much of those gains, with a recent share price of $9.31, it is still trading at a steep 25.2 percent premium to its NAV.
In June, sensing the timing was right for the embargo to be lifted, the fund announced a rights offering, allowing existing shareholders to buy additional stock at a discount. “We wanted the shareholders to benefit,” says Herzfeld, who held 5.75 percent of the fund’s shares by late December. The $12.1 million offering was oversubscribed; the new shares were delivered on December 16, the day before Obama made his historic announcement. “In that respect, our timing was perfect,” Herzfeld adds.
Herzfeld has seen sharp swings in the fund’s share price before. It would soar on the periodic rumors that former president Fidel Castro had died or when Pope John Paul II and Pope Benedict XVI visited Cuba in 1998 and 2012, respectively. Its shares plummeted in 1996 when two planes flown by anti-Castro activists distributing leaflets were shot down by the Cuban Air Force. “Closed-end funds respond with a high sensitivity to news,” Herzfeld says.
Since it began trading, in May 1994, the Herzfeld Caribbean Basin Fund has delivered an average annual return of 6 percent. Performance hasn’t been helped by high fees — the fund sports an expense ratio of 2.46 percent, versus 1.36 percent for the Templeton Emerging Markets Fund, according to Chicago-based Morningstar.
Now, of course, with the fund trading at a premium, the question is whether shareholders should dump their stock. “No one understands the subject of buying closed-end funds at a discount and selling at a premium better than me,” says Herzfeld. Indeed, he wrote the book on it: The Investor’s Guide to Closed-End Funds (McGraw-Hill, 1979). “I don’t have any complaint with people saying you should sell at a premium.”
However, he also says it may be wise to look to the future too. “I would also say not to use the rear-view-mirror approach,” says Herzfeld, who co-manages the fund with son Erik. “Think ahead to what the fund holds and what it will hold going forward.”
A big question for investors is how much the companies in the fund’s portfolio will benefit from the opening of the Cuban market. “Royal Caribbean would obviously benefit by adding Cuba to its list of destinations, but how big of a deal is it?” asks Sumit Desai, a research analyst at Morningstar. “How much does Cuba move the needle?”
One possible but diminutive upside: The fund holds Cuban sovereign bonds, known as “Batista debt,” after Fulgencio Batista, the dictator whom Fidel Castro overthrew in 1959, with a face value of $165,000 that it has been valuing at zero. Herzfeld thinks it’s likely that Cuba will pay the bonds off with interest, especially given that the total government issue was only $30 million. “Wouldn’t it be nice for them to say they paid them all off?” he says.
In any case, Herzfeld has plenty on his plate going forward. His firm manages $275 million to $300 million, including private accounts, and is ramping up a division devoted to direct investments in Cuba. “We estimate under the current laws we could invest $500 million to $1 billion in one year and $10 billion in the next ten years in the projects we have identified across different industries,” Herzfeld says. For a firm like his, the growing Cuban opportunities aren’t just exciting — they are downright revolutionary.
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