Herzfeld Caribbean Basin Fund’s Cash-Stock Distribution Signals Strategic Shift Amid Regulatory Overhaul

The Herzfeld Caribbean Basin Fund, Inc. (NASDAQ: CUBA) has announced a $0.2325-per-share distribution, marking its second payout of the fiscal year and underscoring a broader shift in strategy. The May 9, 2025, announcement reveals a novel twist: shareholders may elect to receive up to 20% of the distribution in cash, with the remainder paid in shares. This hybrid approach, combined with revelations of a planned pivot to a CLO Equity Strategy, signals both opportunity and risk for investors.

Distribution Mechanics and Return of Capital Concerns

The distribution, set to be paid on June 30, 2025, follows a managed policy requiring annual payouts of 15% of the fund’s net asset value (NAV) as of June 30, 2024. Based on the fund’s disclosures, this NAV was $3.10—calculated by dividing the total annual distribution of $0.4650 (two $0.2325 installments) by 15%.

However, the composition of the distributions raises red flags. The current payout is 91.25% net long-term capital gains and 8.75% return of capital, while cumulative return-of-capital contributions for the fiscal year total 54.4% of all distributions. Such returns reduce the fund’s NAV, increasing expense ratios and potentially forcing asset sales to sustain payouts.

This trend highlights the fund’s reliance on structural leverage to meet distribution targets, a risky proposition if NAV declines further.

Strategic Overhaul: From Caribbean Equity to CLOs

The fund’s May announcement is not isolated. A special shareholder meeting on June 17, 2025, will vote on proposals to restructure its core strategy, abandoning its Caribbean Basin focus for investments in equity and junior debt tranches of collateralized loan obligations (CLOs).

The shift requires amending seven fundamental policies, including lifting restrictions on leverage, real estate, and industry concentration. If approved, the fund will rebrand as the Herzfeld Credit Income Fund, Inc., with a primary objective of maximizing risk-adjusted total returns, supported by a secondary emphasis on income generation.

Risks and Regulatory Hurdles

The pivot carries significant risks:
1. Leverage Exposure: The new strategy will likely increase borrowing, amplifying volatility in a rising-rate environment.
2. NAV Erosion: Returns of capital dilute NAV, potentially widening the discount to market price, which already averages 10–15%.
3. Tax Implications: Distributions classified as return of capital reduce shareholders’ cost basis, affecting future capital gains tax liabilities.

Regulatory approvals are also critical. The amended advisory agreement, proposing incentive fees tied to “managed assets,” must align with SEC guidelines.

Shareholder Considerations and Voting

Shareholders face dual decisions:
- Distribution Election: Those failing to return forms by June 16 will default to 100% stock, potentially diluting ownership.
- Proxy Vote: Approval of the strategic shift hinges on votes for the three proposals. The board unanimously recommends “FOR” votes, citing the CLO strategy’s 10–12% annualized return potential in stressed credit markets.

Conclusion: A High-Reward, High-Risk Gamble

The Herzfeld Caribbean Basin Fund’s moves reflect a bold pivot to capitalize on opportunities in the CLO market. However, its success hinges on three factors:
1. NAV Stability: Maintaining the $3.10 NAV base is critical to avoid escalating return-of-capital payouts.
2. Shareholder Approval: Without it, the fund risks losing its ability to pursue higher-yielding strategies.
3. Market Conditions: The CLO equity strategy’s performance will depend on loan defaults and interest rate trends.

While the fund’s 15% annual distribution policy provides income certainty, its reliance on return of capital and the proposed leverage increases underscore risks. Investors must weigh the potential for higher returns against the structural vulnerabilities. For now, the June 17 vote—and the outcome—will set the stage for this fund’s future.