CUBA.NASDAQHerzfeld Caribbean Basin Fund INC

DEF: Herzfeld Caribbean Basin Fund Proposes Major Strategic Shift to CLO Investments and New Fee Structure

Sentiment:

Proxy Statement 3 June 2025 4:35 PM

📋All filings for Herzfeld Caribbean Basin Fund INC

The Herzfeld Caribbean Basin Fund, Inc. is seeking stockholder approval for a significant overhaul of its investment strategy, shifting from Caribbean Basin equities to collateralized loan obligations (CLOs), alongside a new fee structure including an incentive fee and a change in its investment objective and fundamental policies.

Capital raiseThe amended fundamental policies would permit the Fund to borrow money and issue senior securities (such as debt and preferred stock) to the full extent allowed by the Investment Company Act of 1940.Under the 1940 Act, the Fund may borrow up to 33 1/3% of its total assets and issue preferred stock up to 50% of its total assets (including proceeds of issuance, less liabilities not represented by senior securities).Any borrowed amounts or proceeds from senior securities will be included in 'Managed Assets' for fee calculation, which would increase the advisory fees paid to the Adviser.The Adviser intends to use leverage when the expected return on such borrowings is greater than the associated interest expense, subject to Board oversight.While the Fund currently has no borrowing arrangements in place and does not intend to enter into any or issue senior securities, the proposed policies would provide the flexibility to do so in the future.

Summary

A Special Meeting of Stockholders will be held on June 17, 2025, to vote on three key proposals.
Proposal 1 seeks approval for an amended investment advisory agreement with Thomas J. Herzfeld Advisors, Inc., introducing a base management fee of 1.25% of Managed Assets (gross assets including leverage) and a 10% incentive fee on pre-incentive fee net investment income, subject to a 9% annualized hurdle rate.
Proposal 2 aims to revise the Fund's investment objective from 'long-term capital appreciation' to a primary objective of 'maximizing risk adjusted total returns' and a secondary objective of 'generating high current income,' and to reclassify this objective as non-fundamental, allowing future changes without stockholder approval.
Proposal 3 involves amending several fundamental policies of the Fund related to borrowing, issuance of senior securities, underwriting, industry concentration, real estate, commodities, and making loans, to provide greater investment flexibility under the Investment Company Act of 1940.
The Board of Directors unanimously recommends that stockholders vote FOR all three Proposals.
If approved, the Fund's name will change to 'Herzfeld Credit Income Fund, Inc.' and its investment strategy will pivot to primarily investing in equity and junior debt tranches of CLOs, which are collateralized by below-investment-grade U.S. senior secured loans.
The portfolio transition to the new strategy is anticipated to take effect on July 1, 2025, and is expected to last 3-6 months, with an estimated transaction cost of approximately $8,900 (0.02% of estimated NAV as of March 31, 2025) and estimated net capital gains of approximately $13,267,727 if completed by April 25, 2025.

Sentiment

Score: 6

Explanation: The document presents a strategic pivot aimed at improving fund performance and stockholder value by moving to a more established asset class (CLOs) and a fee structure common to that segment. While it introduces new, higher risks associated with CLOs and leverage, the Board's unanimous recommendation and the potential for improved liquidity and distributions suggest a cautiously optimistic outlook on the proposed changes, contingent on stockholder approval and successful implementation.

Positives

The proposed changes are expected to allow existing stockholders to remain invested in a closed-end fund that could provide regular distributions with limited return of capital.
The new strategy leverages the Adviser's core investing expertise in fixed-income and CLOs, including over 10 years of experience investing in CLOs for SMA clients.
There is potential for improved liquidity and a narrower trading discount for the Fund's shares, as the new strategy aligns with asset classes that have historically provided sustainable distributions.
The new fee structure, including an incentive fee, aims to better align the Adviser's compensation with the Fund's performance.
The estimated net capital gains of approximately $13,267,727 from the portfolio transition could be distributed to stockholders.

Negatives

The new fee structure, based on 'Managed Assets' (which includes borrowed funds), may result in higher advisory fees if the Fund utilizes leverage.
The incentive fee component could potentially incentivize the Adviser to make riskier or more speculative investments to generate income, even if capital losses occur.
The significant portfolio transition (selling approximately 100% of current holdings) will incur transaction costs and may result in tax consequences for stockholders.
The new strategy involves investing in high-yield, highly leveraged, and less liquid CLO securities, which carry substantial and different risks compared to the current equity strategy.
The Fund has no prior track record of operating this specific CLO investment strategy in a registered investment company, introducing business risks and uncertainties.
If any of the three proposals fail to receive stockholder approval, none will be implemented, and the Fund will continue under its current strategy, which has faced persistent wide trading discounts.

Risks

Portfolio Fair Value Risk: The limited public market for CLO investments means fair value determinations may materially understate or overstate actual realized value.
Potential Conflicts of Interest Risk – Allocation of Investment Opportunities: The Adviser manages other funds with similar investment objectives, potentially leading to conflicts in allocating investment opportunities.
Collateralized Loan Obligations Risk: CLOs are generally backed by below-investment-grade assets, and junior tranches (the Fund's focus) are the first to absorb losses, with complex structures potentially leading to unexpected results.
Covenant-Lite Loans Risk: Underlying CLO loans may have fewer protective covenants, increasing the risk of loss for the Fund's CLO investments.
Subordinated Securities Risk: CLO equity and junior debt securities are subordinated to more senior tranches, increasing their risk of default.
High Yield Investment Risk: Investments are typically unrated and speculative, involving greater credit and liquidity risk than investment-grade obligations.
Default Risk: Decline in value or failure to pay interest/principal on underlying CLO assets or other credit investments can adversely impact the Fund's income and NAV.
Non-Diversification Risk: As a non-diversified investment company, the Fund's investments involve greater risks due to less limitation on asset concentration in a single issuer.
Leverage Risk: The use of leverage, directly or indirectly through highly leveraged CLO equity securities (typically 9-13 times), magnifies the risk of loss.
Reliance on Senior Management Personnel of the Adviser Risk: The Fund's success depends significantly on the continued service and coordination of the Adviser's senior management team.
Conflicts of Interest Risk: Fund executive officers and trustees may serve other entities, potentially leading to conflicts in time allocation and interests.
Liquidity Risk: The market for CLO securities is more limited, potentially hindering the Fund's ability to sell investments quickly or at fair value.
Risks Related to the Adviser's Incentive Fee: The incentive fee is based on income regardless of capital losses, potentially incentivizing riskier investments or excessive leverage.
Market Risks: Political, regulatory, economic, and social developments, as well as market disruptions, can affect investment values.
Inflation Risk: General risk that inflation could erode the value of investments.
Interest Rate Risk: Changes in interest rates can significantly affect the price of investments, and rising rates may increase loan defaults.
Credit Spread Risk: Widening credit spreads can quickly reduce market values of below-investment-grade securities.
Prepayment Risk: Underlying CLO assets are subject to prepayment, and inability to reinvest at comparable rates can adversely impact performance.
Reinvestment Risk: CLO cash flows may be reinvested in substitute assets at lower yields, reducing excess interest-related cash flow.
Volatility Risk: Refers to the magnitude of price movement in financial instruments.
Equity Risk: Adverse equity market conditions could negatively impact the ability of borrowers to make payments on loans underlying CLOs.
Foreign Exchange Rate Risk: Investments denominated in non-U.S. currencies are subject to currency depreciation.
Cybersecurity Risk: Threats to information technology infrastructure could disrupt operations or affect financial condition.
Tax Risk: Uncertainty regarding CLO equity qualification under the RIC asset diversification test; failure to qualify could result in corporate taxes.
Limited Prior Operating History Risk: The Fund has no prior track record of operating the new CLO investment strategy in a registered investment company.
Refinancing Risk: Debt refinancing may occur at a higher cost or less favorable terms, impacting liquidity and growth.
CLO Warehouse Risk: Participation in CLO Warehouses involves subordination and risk of loss if the CLO transaction does not proceed.

Future Outlook

The Fund anticipates a significant strategic shift to CLO equity investments, aiming to maximize risk-adjusted total returns and generate high current income. This transition is expected to commence on July 1, 2025, following stockholder approval, and is projected to take 3-6 months. The Board believes this new strategy will enable regular distributions to stockholders, leverage the Adviser's expertise, and potentially improve liquidity by narrowing the Fund's trading discount. While the new fee structure may lead to higher fees with leverage, it is intended to align the Adviser's interests with the Fund's performance. The Fund acknowledges the new risks associated with CLO investments and leverage.

Management Comments

"The Board of Directors, including all of the Directors who are not interested persons... unanimously recommends that you vote FOR each of the Proposals."
"The Board considered that the revised investment objective would allow existing stockholders of the Fund to remain invested in a closed-end fund that would be expected to provide regular distributions to stockholders with limited, if any, return of capital, leverage the core investing expertise of the Adviser, and provide the potential for improved liquidity by narrowing the Funds trading discount."
"The successful implementation of the changes included in the Proposals relies on the approval of ALL Proposals."
"The Board has determined that each of the changes included in the Proposals are in the best interests of the Fund and its stockholders and recommends that the stockholders vote FOR each Proposal."
"The Board noted that the asset-based fee of 1.25% of managed assets, incentive fee of 10% and hurdle rate of 9% compared favorably to all of the identified funds and, therefore concluded that the New Advisory Fee Arrangements appeared to be competitive."
"The Directors, noted that the CLO equity asset class requires a different investment skill set, greater resources, and is generally considered a more difficult asset class to analyze than the Funds current investments in exchange listed equity securities of companies based in the Caribbean Basin region."

Industry Context

The proposed strategic pivot from a niche, politically sensitive 'Caribbean Basin' equity strategy to a Collateralized Loan Obligation (CLO) equity strategy represents a move towards a more common and potentially more stable income-generating asset class within the closed-end fund industry. Many closed-end funds utilize CLO strategies for their income potential and ability to employ leverage. The document explicitly states that the proposed fee structure is 'consistent with fee structures of existing registered closed-end funds engaged in CLO strategies,' indicating a strategic alignment with established models in the closed-end fund market. This shift is likely intended to address the Fund's persistent trading discount and enhance its appeal to investors seeking income and risk-adjusted total returns, a common objective for CLO-focused funds.

Comparison to Industry Standards

The proposed management fee of 1.25% of Managed Assets and a 10% incentive fee with a 9% hurdle rate is stated to "compare favorably to all of the identified funds" with similar CLO equity strategies, suggesting competitiveness within the CLO closed-end fund market.
The Board noted that the CLO equity asset class generally requires a different investment skill set and greater resources compared to the Fund's current investments in exchange-listed equity securities of companies based in the Caribbean Basin region, implying a shift to a more complex but potentially higher-yielding asset class common among specialized funds.
The Board considered the asset growth and trading activity of other closed-end funds with similar CLO strategies, indicating that the new strategy aligns with models that have demonstrated potential for increased assets and improved trading volume in the industry.

Management Changes

Role	Previous Person	New Person	Effective Date	Reason
Director	NA	Brigitta Herzfeld	December 31, 2024	Appointment as a director of the Fund.

Corporate Governance

Change Type	Description	Effective Date	Impact Assessment
Investment Objective Reclassification	Reclassify the Fund's investment objective from a fundamental policy to a non-fundamental policy, allowing the Board to make future changes without stockholder approval.	Following stockholder approval of Proposal 2b	Provides greater flexibility for the Board to alter the investment objective in response to market conditions or regulatory changes, potentially reducing future proxy solicitation costs and delays.
Fundamental Policy Amendment Borrowing	Amend the policy to permit borrowing money to the full extent permitted by the 1940 Act (generally up to 33 1/3% of total assets), for investment purposes, temporary liquidity, or share repurchases.	Following stockholder approval of Proposal 3a	Increases the Fund's flexibility in utilizing leverage to implement its investment strategy, but introduces additional costs and risks inherent to borrowing.
Fundamental Policy Amendment Issuance of Senior Securities	Amend the policy to permit the issuance of senior securities (including debt and preferred stock) to the full extent allowed by the 1940 Act (e.g., requiring 300% asset coverage for debt and 200% for preferred stock).	Following stockholder approval of Proposal 3b	Provides additional flexibility to use senior securities for leverage, but introduces risks such as potential forced sales of investments to maintain required asset coverage and costs associated with issuing preferred stock.
Fundamental Policy Amendment Underwriting Securities	Amend the policy to permit underwriting securities of other issuers only insofar as the Fund may be deemed an underwriter under the Securities Act in connection with the disposition of its portfolio securities.	Following stockholder approval of Proposal 3c	Provides maximum flexibility while maintaining compliance with statutory requirements; not anticipated to materially change the Fund's operations or risk profile.
Fundamental Policy Amendment Industry Concentration	Amend the policy to clarify that investments in CLOs, CBOs, CDOs, swaps, or other derivatives will be considered investments in the industry of the underlying or reference security for the 25% industry concentration limit.	Following stockholder approval of Proposal 3d	Provides additional clarity for compliance with industry concentration limits under the new CLO-focused strategy; not expected to materially change the Fund's operations or risk profile.
Fundamental Policy Amendment Purchasing or Selling Real Estate	Amend the policy to prohibit direct purchase or sale of real estate or interests, but explicitly permit investments in securities secured by or representing interests in real estate (e.g., mortgage loans) and companies engaged in the real estate business.	Following stockholder approval of Proposal 3e	Provides additional flexibility to implement the proposed new strategy while maintaining compliance with the 1940 Act; not expected to materially change the Fund's operations or risk profile.
Fundamental Policy Amendment Purchasing or Selling Commodities	Amend the policy to prohibit the purchase or sale of commodities, except to the extent permitted under the 1940 Act, allowing for forward foreign currency exchange contracts, options on foreign currencies, and futures contracts.	Following stockholder approval of Proposal 3f	Provides additional flexibility while maintaining compliance with the 1940 Act; not expected to materially change the Fund's operations or risk profile.
Fundamental Policy Amendment Making Loans	Amend the policy to prohibit making loans, except to the extent permitted by the 1940 Act or SEC interpretations, clarifying that the purchase of debt obligations (including loans) does not constitute making loans.	Following stockholder approval of Proposal 3g	Provides additional flexibility to implement the proposed new strategy, particularly regarding debt instruments, while maintaining compliance with the 1940 Act.

Related Party Transactions

The proposed amended and restated investment advisory agreement is between the Fund and Thomas J. Herzfeld Advisors, Inc., which is owned by Thomas J. Herzfeld, and whose officers also serve as officers of the Fund.
The Adviser has voluntarily waived a portion of its management fee until June 30, 2025, as part of a discount narrowing strategy.
The cost of soliciting proxies for the Special Meeting will be borne equally by the Fund and the Adviser.

Stakeholder Impact

Shareholders: Potential for regular distributions and improved liquidity, but exposure to new, higher-risk CLO investments, potential for higher fees due to leverage, and tax consequences from portfolio transition. Loss of direct exposure to Caribbean Basin equities.
Adviser (Thomas J. Herzfeld Advisors, Inc.): Potential for increased compensation through a new fee structure based on managed assets and an incentive fee, aligning with industry standards for CLO managers. Increased management burden due to the complexity of CLO assets.
Board of Directors: Increased flexibility in managing the Fund's investment objective and policies if proposals are approved, potentially enhancing their ability to respond to market changes.

Next Steps

Stockholders are required to vote on Proposals 1, 2, and 3 at the Special Meeting on June 17, 2025.
If all proposals are approved, the Fund's name will change to 'Herzfeld Credit Income Fund, Inc.'
The portfolio transition to the new CLO investment strategy is anticipated to take effect on July 1, 2025, following stockholder approval.
The portfolio transition is expected to take 3-6 months, with sales and purchases of less liquid securities potentially taking longer.
Any net capital gains resulting from the portfolio transition will be distributed to the stockholders of the Fund.
If any of the Proposals are not approved by stockholders, the Board will consider alternative options but will be required to continue managing the Fund under its current investment objectives and strategies.

Key Dates

Date	Description
September 10, 1993	Effective date of the Original Investment Advisory Agreement.
September 1994	Fund's inception.
May 2019	Managed Distribution Policy adopted by the Fund.
September 30, 2019	Quarterly distributions began under the Managed Distribution Policy.
January 1, 2022	All new issue CLO securities began utilizing SOFR as the LIBOR replacement rate.
After June 30, 2023	All tenors of LIBOR ceased to be published or are no longer published on a representative basis.
August 4, 2023	Board modified the Tender Offer Policy.
September 30, 2023	Quarterly distribution suspended due to the Fund's concurrent non-transferable rights offering.
November 2023	Quarterly distribution reinstated by the Board.
December 13, 2023	Non-transferable rights offering concluded.
March 19, 2024	Tender offer expired, resulting in the repurchase of 10% of then-outstanding shares.
May 2024	Board extended the Managed Distribution Policy and Tender Offer Policy through June 30, 2025.
June 30, 2024	Fiscal year end for the Fund's Annual Report.
August 15, 2024	Existing Investment Advisory Agreement was last approved by the Board.
November 2024	Adviser notified the Board of considering changes to the Fund's investment approach.
December 31, 2024	Semi-Annual Report date; Adviser had approximately $850MM in assets under management; Brigitta Herzfeld's appointment as a director.
January 2025	Special Board meeting where the Adviser updated the Board on market conditions and proposed the new strategy.
January 22, 2025	Special Board meeting where the Adviser formally presented the New Strategy and proposed amendments to the Existing Agreement.
February 5, 2025	Quarterly Board meeting for further review of the proposals.
February 27, 2025	Board meeting where the New Strategy, revised investment objectives, revised fundamental investment policies, and amendments to the Advisory Agreement were approved, subject to stockholder approval; Brigitta Herzfeld's Form 3 filing date.
March 11, 2025	Erik M. Herzfeld's Form 4 filing date.
March 31, 2025	Date used for estimated NAV in transition cost calculations.
April 3, 2025	Brigitta S. Herzfeld's Form 4 filing date.
April 25, 2025	Hypothetical date for transition completion used for estimated net capital gains calculation.
April 30, 2025	Date for beneficial ownership reporting by directors and executive officers.
May 5, 2025	Record date for stockholders entitled to notice of and to vote at the Special Meeting.
May 7, 2025	End of the period reviewed for Section 16(a) beneficial ownership reporting compliance.
June 3, 2025	Date of the Proxy Statement and approximate date of its distribution to stockholders.
June 13, 2025	Deadline to pre-register for attending the Special Meeting in person.
June 17, 2025	Date of the Special Meeting of Stockholders.
June 30, 2025	Voluntary management fee waiver agreement ends.
July 1, 2025	Anticipated effective date for the realignment and portfolio transition if proposals are approved.

Recommendation

hold

Keywords

Herzfeld Caribbean Basin Fund, CUBA, Closed-End Fund, Investment Strategy Change, Collateralized Loan Obligations, CLO, High Yield Debt, Risk Adjusted Returns, Current Income, Investment Advisory Agreement, Management Fees, Incentive Fees, Fundamental Policies, Leverage, Shareholder Vote, Asset Management, Financial Services, Fixed Income, Alternative Investments, SEC Filing, Proxy Statement

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