The Making of a New Asset Class
During a recent trip to London we were asked what the protestors encamped outside St Paul’s Cathedral would make of us.
With the Occupy Movement excoriating bankers and especially the alternative fund managers we represent – on the surface at least – everything the anti-capitalists hate: emerging-market fund managers based in Switzerland trading third world debt.
But consider this. At Azure Partners we have created a fund of microfinance funds. If ever a business model could win the hearts and minds of a protest aimed at re-distributing wealth to the very poorest, it is making small loans to groups of nascent entrepreneurs in frontier economies.
In spite of its worldwide reach, microfinance remains a largely unknown quantity for investors.
This is understandable: Occupy protestors and investment professionals may well share a common misconception of microfinance as a totally development bank- and NGO- sponsored attempt to alleviate poverty.
Helping the poor has nothing to do with business” is a frequently heard echo.
Yes, it is easy to talk about the benefits microloans provide and it makes good copy – on our last trip to India we met a group of women in a poor district of Mumbai who borrowed money to expand and enhance their independent but linked businesses hand embroidering wedding saris.
But now more than ever it is more important to talk about the hard financial facts of the matter. Microfinance is a business. It has to be a business that makes profits to create sustainable growth and to allow the institutions to extend their reach to more millions of poor borrowers, hitherto totally unbanked.
Since the authors began their active roles in microfinance in 2004, the value of microfinance loans and investments in capital have grown from US$4 billion to US$30 billion, half of it from the private sector. The number of borrowers in emerging countries has grown from 15 million to 130 million. And the World Bank estimates that this number can ultimately grow to over 1 billion borrowers.
Such rapid growth would never have been possible without managing the microfinance institutions as “for profit” businesses with a focus on productivity and efficiency.
Over 120 funds now exist in the microfinance world to funnel investment from the private sector. About one fourth of the total goes into direct private equity investment in the institutions themselves and the remainder into loans.
Funds range from country-specific to regional, to global in terms of diversification, to diversified un-hedged funds in exotic currencies, and to structured funds and SPVs. Today these funds cover to over 50 countries.
So what formerly was a charity- and development bank-based activity has become largely a for profit one, yet one which has a huge social impact in reducing poverty levels, improving sanitation, nutrition, health, and even educational levels.
In the early days of developing this “for profit” orientation for the microfinance industry, we were criticized for “profiting from the poor”. Today experience has shown that the for profit model has become standard for institutions on the ground and for the investment vehicles founded to support them. Why? Profitable enterprises are sustainable, have the reserves to grow and to attract talent, to train people correctly, and to invest, for example, in IT solutions to guarantee a professional and efficient operation.
On the way there have been –and will be more – hiccups. The Andar Pradesh crisis in India has clearly done public relations damage. But this only underlines the importance of imposing the disciplines of traditional lending based on hard-headed criteria and the investor benefits of aggregation.
Funds, which provide a reasonable profit for investors, attract the money that is the fuel that fires the growth of the sector. The social impact is always there, but occurs more quickly and efficiently than in the charity-only sector.
Some of the larger microfinance institutions are now full-fledged banks, taking deposits, and providing many other banking services. Consolidations of institutions, giving exits to investors, are starting to take place. Acquisitions of institutions by large multinational banks are also happening, increasing the value of equity investments in these institutions. And local sources of funding from local banks and equity investors are starting to accompany foreign investors in local operations.
Growth in the sector has come back to 30 plus % per year, after a lull following the Lehman crisis, and the track record of positive returns each year since inception for all funds, and very few defaults of institutions, has been maintained since the year 2000.
To support this impressive growth, most countries have implemented, or are currently implementing specific regulations for Non-Banking Financial Corporations in microfinance. India, for example, is currently passing a legislation that will offer a regulated framework for local microfinance institutions.
Microfinance has three other distinct advantages for the investor, proven over time:
- First, negative correlation with most of the other asset classes worldwide.
- Second, extremely low volatility.
- And third, enormous geographic diversification, lowering risk significantly.
The combination of these factors has provided historical returns between 2.5% and 4% for debt funds, and 12-18% for equity funds.
These advantages, combined with a meaningful social return, have provided attractive “double bottom line” investment opportunities to private and institutional investors.
New financial products are also being developed to extend fund-raising beyond the traditional direct funds that have operated up until now. These match private investors’ needs in terms of liquidity requirements, risk diversification and global exposure to the best funds of the industry.
In such a brief span of time microfinance has come a long way, and can now justifiably be called a new asset class.
Microfinance has, in short, come of age.