For decades, corporate America has been hoping that Fidel Castro's departure would bring an end to the trade embargo, opening the country to U.S. investment. Almost six months after the Cuban leader stepped aside, temporarily handing over the reins to his brother, there are no signs of a transition to democracy or a market economy. But a tiny closed-end mutual fund run out of Miami is already cashing in. The $14 million Herzfeld ( CUBA) Caribbean Basin Fund (CUBA) invests at least 80% of its assets in companies that derive substantial revenue from operations in the Caribbean region. "We are invested in companies that are doing well now, that will continue to do well, and will get significant new business if the embargo is lifted," says Thomas J. Herzfeld, president and chairman of the fund's eponymous adviser. The Caribbean Basin Fund's share price has more than doubled since Castro fell ill this summer. Over the 12 months ended Jan. 18, it has returned 135%, making it the highest-returning closed-end fund over the past year, according to the Closed End Fund Association. The fund is not exactly a pure play on Cuba, since the embargo prevents any U.S. company from investing directly in the island nation. But Herzfeld says each of the companies it's invested in has the potential to significantly increase its business if the embargo is lifted. For example, Florida East Coast Industries ( FLA), the fund's largest holding at 18.73% of assets, operates 351 miles of freight railroad between Jacksonville and Miami. Herzfeld believes that a large portion of the U.S. freight that would make its way to Cuba if the embargo is lifted would have to use those rails.
Of course, trains can't cross the Straits of Florida, which is where Seaboard ( SEB), the fourth-largest holding at 6.61% of assets, comes in. It operates the largest fleet of container ships in the Caribbean. Herzfeld also believes an end to the embargo would be a boon for cruise ship operators like Royal Caribbean ( RCL) and Carnival ( CCL), which represent 4.8% and 4.31% of assets, respectively. He says they generate about 50% of their revenue from the Caribbean, and he believes Caribbean receipts would double after the embargo ends. Herzfeld's strategy involves more than just economic analysis, however; he also employs political savvy. "We are looking at which areas we should invest in and seek out Cuban-American leaders in those industries and try to negotiate joint ventures," he says. The fund manager anticipates that these leaders will be instrumental in rebuilding Cuba. He points out that Florida East Coast Chairman and Chief Executive Adolfo Henriques is a prominent Cuban exile who was named one of the 12 most powerful people in Miami by The Miami Herald. Investors who want to buy the Caribbean Basin Fund now will have to pay up, however. Its shares are currently trading at a 102% premium to their net asset value. Unlike open-end mutual funds, which issue and redeem shares once a day at their net asset value, closed-end funds issue a fixed number of shares that trade throughout the day on an exchange. So their prices can rise and fall independently of the value of their holdings. Anyone who invests in the Caribbean Basin Fund now runs the risk that the shares' premium to net asset value may have fallen -- or even swung to a loss -- when they are ready to sell.
In fact, just 12.56% of the fund's return over the past year has come from an increase in its net asset value. The remainder is attributable to the rise in its share price, which spent the first half of last year at a discount to NAV. That's an important consideration, given the likely pace of change in Cuba. So far, the transfer of power "has been notably smooth and stable," writes Julia Sweig in the January/February 2007 issue of Foreign Affairs magazine. "Cubans have not revolted ... not one violent episode in Cuban streets, and no massive exodus of refugees. Within Cuba, whether Fidel himself survives for weeks, months, or years is now in many ways beside the point." But this doesn't deter Herzfeld. "No one should believe, nor do we, that the embargo would be lifted immediately," he acknowledges. "And it should only be lifted if the Cuban government takes steps to restore democracy, freedom and capitalism. That said, however, the single most important development toward that would be the death of Fidel."