Benchmarking Microfinance Equity Investments

December 15, 2010

Benchmarking Microfinance Equity Investments

Microfinance, generally understood to mean the provision of financial services (particularly microloans) to poor people in developing economies, is increasingly attracting international institutional investor attention as an alternative asset investment opportunity, particularly as a socially responsible and financially attractive way to promote human well-being. The California State Teachers’ Retirement System’s (CalSTRS) proposal to include microfinance as an eligible asset in its alternative assets allocation is just one recent example of this trend.1

Yet there has been no consistent measure of performance of equity invested in the providers of microfinance. This article outlines the growing need for such measures and the approach used to create the first indexes for this new asset category—the WSAS Microfinance Institutions Shareholder Value Indexes.

The Evolution Of Microfinance Institutions2
Specialized financial institutions that provide microfinance services, generically called “microfinance institutions” (MFIs), arose from humanitarian efforts to meet the financial needs—principally the credit needs—of very poor people in developing economies. Grameen Bank in Bangladesh is one widely recognized name in this regard.

MFIs take many possible legal forms, including nonprofit, nongovernmental organizations (NGOs); member-owned cooperatives/credit unions; nonbank financial institutions; and licensed, deposit-taking banks, with the latter two forms most commonly being shareholder-owned.

Experience has shown that MFIs, to be truly effective in the long term in meeting the needs of their communities, need to be financially self-sustaining; that is, they need to produce a financial surplus to their operating and funding costs. And to truly scale up operations, they need to tap commercial sources of funding; in particular, equity finance.

Equity Investment In MFIs3
While there were several far-sighted institutional equity investors in MFIs before 1995, the period since 2004 has seen the start of a boom of equity investment in MFIs that shows signs of only accelerating.

Investments in specialized funds and investment vehicles are the principal channels for this. A survey of the microfinance funds industry by the MFI rating and information services company MicroRate, using 2008 data for 68 microfinance investment vehicles (MIVs)4—which invest the pooled assets of multiple investors with MFIs—found that such MIVs had about $490 million in equity investments, compared with about $78 million in equity from specialized MIVs in 2005.

The Consultative Group to Assist the Poor (CGAP), using different definitions of MIVs/investors (including development finance institutions not covered by MicroRate), found about $1.5 billion invested by the end of 2008. This compares with CGAP’s findings of $370 million at the end of 2006.

There are a number of reasons for this trend, including:

  • The demonstrated and enduring good return on equity (ROE) performance of high-profile MFIs—top-quartile performers turning in annual ROE of around 20 percent;5
  • The very positive publicity surrounding microfinance and “Bottom of the Pyramid” business opportunities in developing economies, such as the UN’s Year of Microcredit (2005), the awarding of the Nobel Peace Prize to Dr. Muhammad Yunus and Grameen Bank (2006), and the favorable feature articles on MFI results in Forbes magazine (2007);6
  • The success of initial public stock offerings by MFIs such as Compartamos Banco and Financiera Independencia (Mexico, 2007); and
  • The growing equity capital needs of MFIs (as established ones grow, new ones are launched, and nonprofits are “transformed” into shareholder types), resulting in larger investment opportunities.

Further, studies have indicated that the recent financial results of MFIs’ operations tend to be largely insulated from domestic economic downturns. Moreover, their financial results have been largely uncorrelated to traditional asset classes, suggesting MFI equity investments can help diversify the sources of risk and return for broad-based portfolios.7

The microfinance-specific trends have been supported by broader trends in the capital markets. Microfinance opportunities exist as a bridge of two traditional asset classes—emerging markets and private equity—and both of those market segments have been performing very well recently.

In short, it seems equity investors could “do well while doing good” by investing in carefully selected MFIs—or simply do well financially, if doing good wasn’t an investment requirement. Their experiences in emerging markets public and private equity make them willing to dip their toes in the MFI equity pool.


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