CUBA and the Long Road Back to Market Efficiency

The efficient-market hypothesis (EMH) assumes that investors have “rational expectations.” This is the idea that, on average, the population is correct and whenever new information appears, expectations are updated appropriately.

Wonderful in theory, but in the real world investors are anything but “rational.” As human beings, we tend to overreact to new information, behaving in an irrationally exuberant or irrationally despondent fashion (for our own research on a market inefficiency, click here).

A clear example of this irrational behavior was on full display last December.

As I wrote at the time, with the announcement of U.S. policy changes toward Cuba, investors scrambled for ways to “play it.” Their vehicle of choice quickly became the Herzfeld Caribbean Basin Fund, a closed-end fund with the ticker “CUBA.” In the course of a week, the fund more than doubled in a vertical move higher accompanied by a substantial increase in volume.


While the ticker was “CUBA,” there was no actual Cuban companies in the fund’s holdings, only companies that “might benefit” from a shift in policy towards Cuba. This minor detail did not matter. Investors bid up shares in CUBA to an astounding 70% premium over net asset value.

In an efficient market, such a wide divergence would never happen, as arbitrageurs would have stepped in, shorting the fund while buying the underlying holdings to earn a “riskless” profit. In an efficient market, no investor would have chosen to buy CUBA at a 70% premium when they could buy the underlying holdings at no premium at all.

But the market is not entirely efficient and it took a year for the price of CUBA to move back to its NAV. Yesterday, it closed at $6.45, slightly below its NAV of $6.53.

cuba 12-16

The lesson here is as old as time. The markets are far from efficient and a key reason for that is that investors are far from rational. The CUBA fund is merely one example. It has happened before and it will happen again as long as human behavior is a driving force in markets.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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