WHAT is microfinance? “Microfinance” is financial services for the global poor.

Financial services are provided by “microfinance institutions” (MFIs) or “microlenders”, generic terms for the estimated 10,000 diverse entities such as commercial banks, NGOs, credit unions, finance companies etc. These services include providing business and housing loans, insurance, pensions, and deposits. The prospects for this industry are strong since the gap between demand and supply is great. Currently, an estimated 4 percent of the overall global demand for microfinance services is being met. Although estimates vary widely, the potential global microfinance market is worth approximately $300 billion. The commercialization of microfinance is gaining momentum as non-profit charities convert into regulated financial institutions. Nonetheless, an estimated 90% of the (non-deposit) capitalization in microfinance is public funding in origin, although often filtered through a private intermediary. Recently, we have seen public agencies work to guarantee layers of private investment funds into order to attract commercial investors. Will an asset class emerge?

WHY does commercial microfinance work? Poor people around the world produce very high marginal returns on capital, and need financial services to exploit these opportunities.

The high cost of capital in the developing world (20-100% APR), the high demand for credit, and the low cost of labor, make transaction-intensive microfinance quite profitable if done right. Moreover, due to the low delinquency and default rates on micro-loans, the (elite few) high-performing microlenders’ earnings are stable and strong (ROA of 3-8%). There are numerous other factors that also make the industry attractive, including low systematic risk, low volatility, and strong diversification of micro-loan portfolios (Source: Blue Orchard). Of course, there are many significant risks as demonstrated by the fact that only 3% of microlenders around the world actually turn a profit.

HOW to invest in microfinance? Participate in one of the many funds providing returns to investors.

The microfinance universe of funds is fledgling. Nonetheless, well guaranteed returns of 0-7% annually are offered. Unfortunately, you cannot ask your money manager about investing in microfinance. Responsible capitalistic investment in microfinance is still labor intensive in that each fund requires individualized contact.

Relatively large minimum investments further limit your options. Almost all of the funds have a minimum investment of $50,000 dollars. Two funds that accept small amounts are PlaNet Finance Fund and Calvert Community Investment Notes, while Dexia Microcredit Fund and Deutsche Bank Microcredit Development Fund are examples of funds with significantly larger minimum requirements.