Despite suffering some negative perceptions, the asset class is cleaning up its act and gaining new fans, says Nina Röhrbein
Microfinance, the provision of financial services to poor people, can divide opinion. It is either seen as a solution to alleviate poverty or viewed as a loan-shark business that takes advantage of the most vulnerable. Scandals such as Nicaragua’s No Payment Movement and the suicides of over-indebted clients in the south Indian state of Andhra Pradesh in 2010 did not improve the industry’s reputation.
But investors in microfinance have learned to take the rough with the smooth. “We tend to view microfinance as an asset class and try to manage its positive and negative aspects,” says Jonas Ahlén, investment manager, alternative investments and fund selection, at Storebrand Investments in Sweden. “The sector has had a bit of an image problem but today more people take a balanced view of the sector. Managing the built-up expectations of investors and the financial and social aspects of microfinance are key for the sector to move away from the perceived bad image.”
Storebrand started investing in microfinance in 2005 as part of the firm’s responsible ownership profile. Initially, it was viewed as a social profile investment but as the portfolio grew to its present $50m, financial aspects such as diversification, low volatility and low correlation to other asset classes became equally important.
The Scandinavian asset manager is primarily an investor in debt and equity funds but also has two direct investments in microfinance institutions (MFIs) and one investment in the Norwegian Microfinance Initiative. It provides funding to the sector through equity capital to support growth and expansion of socially minded MFIs and through loans to refinance the lending business of strong institutions.
Netherlands-based Pensioenfonds PNO Media became a microfinance investor in January 2010. At present, it has €25m - close to 1% of its portfolio - invested in microfinance, through a 90% debt and 10% equity vehicle of Dutch SNS Asset Management.
“SNS Asset Management helped us in making sure that we are in control of the microfinance process, which is a relatively young sector with a new set of governance developments,” says Jeroen van der Put, executive director at PNO Media.
Nevertheless, risks cannot be completely ruled out and PNO Media has had to write off two MFIs in India.
Cross-border funding, in other words, commitments from public and private donors and investors in microfinance, made up $24bn (€18.3bn) at the end of 2010, up 13% on the previous year, according to the Consultative Group to Assist the Poor (CGAP). Overall growth in the sector, however, has slowed.
“Some microfinance markets became overheated recently, which is why there is more caution in the market now,” says Antonique Koning, microfinance specialist at CGAP. “Funds have to some extent slowed their growth in their portfolio as a response to the market interest and demand.”
According to microfinance investment platform Symbiotics, leading MFIs grew by 20% per annum over the past five years, compared with 50-60% before 2008.
Currently, the debt market stands at $4-5bn and the private equity market at $1bn, according to Xavier Pierluca, CIO financial services at Bamboo Finance Private Equity.
But big changes are under way. In the past, the assumption was that low-income clients wanted micro credit and standardised products. “But, over time, the industry has realised that low-income clients need a broader range of financial services that are more adapted to their needs,” says Koning. “There is also an increased focus on ensuring that the delivery of financial services is done responsibly as well as on business model innovation related to technology, particularly through the use of mobile phones.”
“There will also be an evolution towards SME financing,” adds Pierluca. “Many successful MFIs will move markets to target the missing middle, which is important as it provides formal employment in developing countries.”
As the industry matures, microfinance investments are becoming more sophisticated. Most microfinance funds have been providing funding into MFIs in hard currency, such as dollars or euros but more and more funds are springing up with solutions in local currency.
Smaller funds, regional funds and funds-of-funds investing in debt and private equity microfinance funds are also part of the innovation in the sector.
“A wider selection of funds makes it easier for investors to differentiate and choose a fund of their choice,” says Patrick Elmer, head responsible investments and philanthropy at Credit Suisse in Zurich.
Debt remains the primary instrument used to fund microfinance but its share in total commitments decreased from 68% in 2008 to 60% in 2010, according to CGAP.
Two thirds of the 120 microfinance funds worldwide are debt funds, estimates Vincent Oswald, managing director at Azure Partners, a Swiss-based microfinance fund of funds managers, with the rest being private equity.
With many NGOs having converted to full-profit entities or fully fledged banks, part of their funding is coming from the mobilisation of savings, enabling many mature MFIs to close up to 70% of their loan portfolio through savings.
“Debt is becoming more of a commodity for microfinance organisations, even if it is still needed in many countries where local commercial banks are unwilling to lend to MFIs,” says Pierluca. “In the more mature markets, the fact that mobilising savings is much cheaper than attracting debt from microfinance investment vehicles (MIVs) is commoditising the provision of debt to MFIs and pushing down the returns, whereas equity will be needed for many types of projects to maintain capital adequacy ratios that are accepted by the different regulatory authorities. Equity is also needed for acquisition and cross-border regionalisation strategies, which we are starting to see more of.”
Pierluca estimates the investable market potential of private equity microfinance funds to be $8bn. Latin America remains the biggest and most mature region in which microfinance funds invest in through MIVs. Another hub for MFIs is Southeast Asia, while Eastern Europe, a popular pool in the past, has become less attractive due to high levels of indebtedness.
“Regional allocations depend on available investment opportunities and their potential to contribute to meaningful and socially responsible growth in the sector,” says Ahlén. “We have a global mandate within developing, low- to middle-income countries, meaning our portfolio is spread particularly across Latin America, eastern Africa and south Asia. Our exposure to the Balkan countries is falling due to the redemption of some of our early debt investments.”
Most of the impact of the financial crisis was felt through the combination of regular high inflows from investors and decreasing demand for funding from MFIs in the field.
“Because the performance was stable during the crisis, a lot of cash destined for the sector piled up,” says Elmer. “Then the sector was hit with a time-lag of six to nine months from the crisis, repayment rates from micro-entrepreneurs on the ground worsened and demand for micro loans fell rapidly. This led to many investment funds sitting on large amounts of cash.”
But the financial crisis also had some positive effects, according to Pierluca. In countries where microfinance was greatly atomised, it allowed for consolidation. Inefficient players disappeared, leaving room for well-structured organisations with better governance systems, credit methodologies and diversified sources of funding.
“The recent crisis in India has resulted in the establishment of a regulatory system with an all-encompassing legislation on microfinance and the creation of credit bureaus, which mitigate the risk of over-indebtedness, one of the biggest challenges for microfinance,” he says.
Another change under way involves transparency, the lack of which has blighted the sector in the past.
The Smart Campaign was launched in 2008 to implement a common code of conduct for MIVs and MFIs. Its resulting Client Protection Principles (CPPs) have been widely accepted by the industry.
The MFTransparency initiative, the Microfinance Information Exchange and the Principles for Investors in Inclusive Finance (PIIF) are also working to increase transparency in the sector.
One issue that remains is the limited size of microfinance investments. Pension funds are likely to invest $10-100m in one ticket. This means that many funds are too small for their needs.
“The biggest challenge is scaling up and doing that in a cost-effective way for clients and providers,” says Koning.