Imagine, if you will, hedge fund managers sipping mojitos and smoking cigars on a Havana veranda after a hard day of stock-and-bond trading in Cuba. A pipe dream? Some investors say it’s plausible. A few hedge fund managers even seem to think the opportunity is now.
Cuba, in fact, is one of several unlikely places attracting hedge fund money. Other so-called frontier markets include North Korea and sub-Saharan Africa.
But Cuba holds a certain forbidden allure because of its long estrangement from the U.S., where investors are prevented by law from trading in Cuban assets. Hedge funds based in Europe and the Middle East, which have no such restrictions, are placing bets on Cuban distressed debt, buying up loans made by foreign commercial banks to Havana in the 1980s on which the government of Fidel Castro declared a moratorium on interest payments in 1986.
These defaulted loans — which total about $1 billion in principal (and are worth approximately $3 billion including the accrued interest) — trade today at 15 to 17 cents on the dollar.
This debt could increase in value if U.S.-Cuban relations change. In February, Castro handed power to his brother Raul, who has promised to liberalize the economy. Some political pundits say that when the Bush administration leaves office eight months from now, rapprochement between Washington and Havana may at long last occur, bringing with it a restructuring of the debt — and big profits for the debt holders.
“We’ve seen it happen in the case of other countries that have defaulted, such as the former Yugoslavia, where the breakup of the country led to a default in debt and then paper performed pretty quickly after the resolution of the conflict,” says Stuart Culverhouse, chief economist at Exotix, a London-based securities firm specializing in brokering the illiquid loans, equity and bonds of such esoteric markets as Bosnia, Cuba and North Korea. Exotix also plumbs emerging markets in Latin America, the Middle East and North Africa.
By all accounts, Cuba has nowhere to go but up. The World Bank says the country’s population is approaching 11.5 million. It remains a developing country 49 years after Castro came to power. Only about half the country’s roads are paved, about one in ten people have a telephone, and less than 5 percent of the population has Internet access. The country’s economic struggles have been magnified since the former Soviet Union withdrew most of its subsidies in the late 1980s.
Culverhouse cautions that Cuba could remain in default forever on its outstanding loans. But he says there’s hope: “What we’ve seen in the past few months — especially since Fidel announced that he was stepping down — is heightened interest from non-U.S. hedge funds. We’re seeing a lot of demand for the paper from people who are buying into the story [of change in Cuba].”
One recent buyer is Morten Bugge, managing partner and CIO of Global Evolution, a Danish emerging-markets hedge fund with $400 million in assets under management. Though his fund holds Cuban debt, he is cautious.
“The fact that Fidel Castro has stepped down is a small step in the right direction,” Bugge says, “but he remains in the background, pulling the strings.” Moreover, he adds, much of the defaulted debt is tightly held by investors who, having waited patiently for this long, are loath to sell until things change and the debt goes up in value.
Bugge says he expects “real price movement on Cuban debt” when — and if — three things happen. First, the death of Fidel Castro, who is 81 and in ill health. Second, the lifting of the U.S. economic embargo against Cuba. (Bugge says he expects relations to be restored if Barack Obama, the apparent Democratic nominee, beats Republican John McCain in November.) Third, the start-up of “any talk about restructuring debt.”
Of course, the conditions might never be met, and U.S.-Cuba relations might not be restored for years to come, but then again it could all transpire within a year or two.
Bugge, who will travel to Havana in June to meet with government officials, private companies and banks, says Cuba has an untapped economic potential that is compelling as a long-term investment.
He is not alone in this assessment: Ceiba Investments, a closed-end fund based on the British island of Guernsey and aimed specifically at Cuba, announced in April that it would list on the London Stock Exchange in June. The fund focuses on tourism and real-estate development, both long-neglected sectors under Castro, though Ceiba’s managing director, Sebastiaan Berger, says its strategy is not just to turn a quick buck. “We are not an event-driven fund,” he explains. “We are investing in ventures that make sense today in Cuba, and our aim is long-term capital growth.”
