In focus - Markets

What is microfinance and why does it matter for investors?

Microfinance is a promising way to address global problems such as poverty, inequality and environmental damage. But what’s in it for investors?

01/11/2019

Andrew Lacey

Andrew Lacey

Investment Writer

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Exclusion from the financial system is widely regarded as a major obstacle to people’s efforts to grow out of poverty. In 2017, 1.7 billion adults across the globe had no access to a bank account, with the vast majority of them living in emerging and frontier markets. 56% of these were women, and 59% of these women did not participate in their country’s labour force, according to the World Bank.

Facilitating access to financial products, tailoring financial services and connecting capital markets to individuals with business can therefore bridge a major gulf in escaping poverty. This is where microfinance, a form of impact investing, comes in.

Microfinance institutions (MFIs) provide loans and (increasingly) savings, insurance and related products to groups with low-income, as well as micro, small and medium enterprises, to enable income-generating activities and help people to break out of poverty. 

How can microfinance fight poverty?

Peter Fanconi, Chairman of the Impact Investment Manager BlueOrchard, can attest to the influence that access to capital can have.

“A five year investment of $1 million can benefit the lives of over 55,000 people. These are large numbers, but at the end of the day it is not about the numbers. It is about human beings, about individual stories, about families, about desires and hopes.

“I have seen loans like those facilitated by BlueOrchard support a single mother in setting up a successful embroidery business in Colombia. Not only did the business provide her with financial independence, but it now employs 20 other women.

”A similar loan allowed an agriculturalist and beekeeper from Tajikistan to expand his business and improve his family income without being forced into an urban area. He is one of the 42% of BlueOrchard end clients living in rural areas whose living conditions improved with access to the financial system.”

These are only two examples. The positive social impact of impact investing and microfinance in particular - especially with regards to eradicating poverty - seems clear. 

How can investors benefit?

Proving that an inclusive financial system is a positive step towards sustainability and development goals is arguably therefore straightforward. A society that has access to financial services has the potential for better entrepreneurship prospects and job creation. It can provide individuals the tools to improve their livelihoods on a number of levels, including financial security, healthcare and education.

Acknowledgment of positive social impact should not, however, overshadow financial diligence and investment returns. The sustainability of a microfinance model is predicated on its long-term viability for investors. If it doesn’t work for those lending the capital, it can’t continue to work for recipients of microfinancing.

“The potential for stable and competitive returns – along with low default rates – are just some of the factors convincing more and more investors that microfinance is in a class of its own. You can achieve market returns while doing good,” says BlueOrchard’s CEO Patrick Scheurle.

Mr Fanconi is also confident that microfinance could offer investors not only an attractive return, but diversification benefits that are increasingly sought after in the current environment of slowing economic momentum.

“Over the past 20 years we have seen a 4.3% annual rate of return from our microfinancing activities.

"Over that same period, the default rate has been lower than 1%. We would challenge any developed market bank to match that.

"Importantly, returns  are also uncorrelated with traditional asset classes, and have very low volatility. These characteristics are over and above the positive social benefits, creating what we call a 'double bottom line' impact.”

What risks should investors consider?

Prior to investment, due consideration must be given to potential risks represented by the investee. The below factors are just some of the questions we look at before risking any capital.

  • Does the MFI have a formal policy on multiple loans?
  • Does the institution fully disclose to the clients all prices, instalments, terms and conditions of all financial products?
  • Does the institution have a clear Code of Conduct?
  • Does a formal mechanism to handle customer complaints exist?

Country specific concerns need to be appraised and maintained as well. Credit worthiness needs to be appraised via consistent and repeatable analysis.

Finding the balance between making a meaningful and a rewarding investment is essential. An investor must be provided the requisite information on its social and environmental impact and their return. On the other hand, the reality of the investment “in the field” must be accounted for, given limitations and capabilities of the target investees.

As with all investments, the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Past Performance is not a guide to future performance and may not be repeated.  If you are unsure of suitability, speak to a financial advisor.

What’s behind the rise of microfinance?

The power that capital and its allocation has to improve some of the world’s most pressing social and environmental problems is huge. In 2006, the United Nations (UN) launched the Principles for Responsible Investment (PRI), putting sustainability in the spot light and kick-starting a change in the way investors considered sustainability in making investment decisions. The PRI framed environmental, social and governance (ESG) factors as an integral part of an investor’s ownership and engagement responsibility, and as a meaningful driver of sustainable returns.

The PRI is immensely influential, with over 2,300 signatories from over 60 countries, representing over $86 trillion, having signed up. It now counts nine in every ten of the largest fund managers in the world as its signatories. ESG has gone from the side lines to centre stage.

In 2015, responsible investing took a further step when the global community, represented by all 193 member states of the UN, adopted the Sustainable Development Goals (SDGs). The SDGs provided signatories with a clear set of sustainable development targets that aim to end poverty, reduce inequality and protect the environment.

The SDGs build upon the work started by the UN Millennium Development Goals (MDGs). Signed in 2000, the MDGs preceded the SDGs, seeking to reduce extreme poverty. The MDGs emphasized the access to microfinance as key in building inclusive financial systems. Set against this backdrop, the UN’s General Assembly designated 2005 as the “Year of Microcredit”, to underline the importance of microfinance. In 2006, Muhammad Yunus won a Nobel Peace Prize for demonstrating the ability for microfinance to successfully enable the working poor to pull themselves out of poverty.

The 17 SDGs are both a clear call to action for the private sector and a statement that the global community relies heavily on the private sector to solve its most urgent problems. Both companies and institutional investors are being asked to contribute to the SDGs through their business activities, asset allocation and investment decisions. Number one on the SDG’s list of targets is to end global poverty.

To read more of Schroders' insights on sustainability, click here.