MICROFINANCE PAPER WRAP-UP: Foreign Capital Investment in Microfinance: Reassessing Financial and Social Returns; By Xavier Reille, Sarah Forster and Daniel Rozas; Published by CGAP (Consultative Group to Assist the Poor)

By Xavier Reille, Sarah Forster and Daniel Rozas; published by CGAP (Consultative Group to Assist the Poor); 2011; 16 pages; available at http://www.cgap.org/gm/document-1.9.50967/FN71.pdf

This document examines the landscape for foreign investment in microfinance and evaluates the financial and social performance of foreign capital in microfinance. The analysis considers data including CGAP’s “Annual Survey on Foreign Investment” and the Microfinance Information Exchange (MIX) Market’s Funding Structure Database.

The authors consider the investment landscape within the following three categories:

1) Development Finance Institutions (DFIs): DFI investment, which has grown from USD 1.7 billion in 2006 to USD 7.5 billion in 2010, constitutes approximately half of foreign investment in microfinance. The authors conclude that these investments, which are largely in the form of hard-currency, fixed-income (debt) instruments, are concentrated in the larger, more established microfinance institutions (MFIs) of Eastern Europe and Central Asia (ECA) and Latin America and the Caribbean (LAC).

2) Institutional Investors: Accounting for approximately 30 percent of foreign investment, this group includes a broad range of institutions and funds, including international banks, private equity funds, pension funds and insurance companies. According to the authors, some international banks are now considering offering microfinance products through their own banking networks, thus directly making microfinance investments in local currencies, and diversifying their portfolios through investments in agriculture, health renewable energy.

3) Retail investors: The authors cite social performance as the primary driving force behind retail investments, which account for approximately 16 percent of foreign investment and are mainly raised through financial cooperatives, such as Oikocredit of the Netherlands, and public placement funds, such as responsAbility Social Investments of Switzerland. The authors state that the growth of retail investments have been hampered by regulations that limit the distribution of microfinance investment funds to the retail market in the United States and Europe.

The authors’ findings indicate that approximately 50 percent of cross-border investment is channeled through microfinance investment intermediaries (MIIs), with microfinance investment vehicles (MIVs) comprising most of this volume. The authors argue that competition among asset managers will lead to the consolidation of microfinance asset management firms, thereby bringing down transaction costs and creating efficiency gains for investors and investees.

The authors further examine the financial performance of fixed-income and equity investments, the two main forms of investment in microfinance. Fixed-income agreements, which represent 85 percent of all MIV investment and 70 percent of direct DFI investment, recorded a historic low return of 2.5 percent in 2010. The authors attribute the low returns to: 1) excess supply of and stagnating demand for foreign debt and 2) lower portfolio quality in some markets leading to higher defaults, thereby necessitating the need for higher loan loss provisioning. The authors expect the low returns on fixed-income investments to continue over the next few years.

Foreign equity, which addresses the relative lack of risk capital within emerging markets, recorded a compounded annual growth rate of 60 percent over the last four years, exceeding the aggregate demand of MFIs that are investment ready. Furthermore, “crises” in markets such as Bosnia and Herzegovina, Nicaragua and India and the overall slowdown in the sector are causing equity investors to revise their return expectations downwards. The authors also cite an emergence of domestic equity investors in developing countries and the down-market expansion of commercial banks through acquisitions of MFIs in mature markets.

The metric used by the authors to measure the social performance of foreign investment is financial inclusion. The authors suggest that a small number of countries in the ECA and LAC regions receive the bulk of foreign investment and experience relatively high levels of financial inclusion. The authors argue that while foreign investment has aided the growth of investee MFIs and helped them to scale up in these regions, investors need to do more to invest in the undeserved markets of Africa and Asia. The authors further state that there is evidence in some markets – particularly Bosnia and Herzegovina and Nicaragua – of the existence of excess capital and insufficient oversight.

In conclusion, following the lower performance of microfinance investments in 2009-2010 and the downturns in Bosnia and Herzegovina, Nicaragua and, most recently, India, the authors indicate the following lessons have been learned:

•Risk-adjusted returns on microfinance investments should be reassessed in the context of the “crises”

•There are disparities among asset managers, and greater emphasis should be placed by investors on engaging those managers with sound investment strategies, robust investment processes and a commitment to social performance

•Increasingly there is a trend whereby funds are diversifying into the broader impact-investment class such as into fair trade, health, education, agriculture and renewable energy.

While this is viewed as a measure to diversify investment portfolios and risk, the authors note that these areas of impact investing require a different set of evaluation techniques and that the returns on such investments are less predictable than the returns from sound MFIs.

By Medha Ravi, Research Associate

About CGAP (Consultative Group to Assist the Poor):
Housed at the World Bank Group, CGAP (Consultative Group to Assist the Poor) is an independent policy and research center dedicated to facilitating the provision of financial access to poor people worldwide. CGAP is supported by approximately thirty development agencies and private foundations. Its mission is to provide market intelligence, to promote standards and to offer advisory services to governments, microfinance providers, donors and investors.

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