Over the past 18 months we have been noticing a growing tendency to declare microfinance either an outright failure (on social or financial grounds, or both), insufficiently “innovative”, or slipping into irrelevance in the face of new technologies and opportunities. We’ve heard these sentiments from both industry outsiders – aspiring impact investors – and insiders, in recent industry meetings and panel discussions, both in the US and abroad. While the motives may vary, the trend is the same – investors seem to be losing interest in microfinance.
As was the case with Mark Twain, we believe that the reports of the death of microfinance are greatly exaggerated, so we’re going to stick around. Before explaining our continued commitment to microfinance, though, we explore some of the reasons for the apparent disillusionment and waning interest and offer our own interpretations…
Financial returns not commensurate with risk
Recent discussions have revealed that many microfinance fund managers have adjusted their forecasts and are now projecting more modest performance with returns for equity investors in funds in the 8-10% range, compared to the previous targets of the 20%+ IRRs at the fund level that were more in line with conventional private equity fund targets. A recent industry report on impact investing suggests that these more moderate microfinance returns are solidly within the range of performance to be expected from impact investments more generally. Impact Investing 2.0, a survey of 12 funds making debt and equity investments in microfinance and other adjacent impact sectors, found that study participants are “meeting or exceeding both their financial and social/environmental impact goals”. For the six case studies currently available on the website, the median net IRR to investors was around 13%, with IRRs ranging from 3% (microfinance debt fund) to 21% (microfinance equity fund). Grassroots’ own survey of performance of 2003-2005 vintage microfinance equity funds that have fully liquidated finds a similar, albeit somewhat lower, range. A look at the Symbiotics Microfinance Index (SMX), which aggregates and tracks the main global fixed income funds targeting microfinance institutions in developing countries, also corroborates these return estimates. SMX had a 3.87% return on an annualized basis with 0.61% volatility since December 2003.
By comparison, since December 2003 the 3-month LIBOR had a 2.08% return but 0.57% volatility, while the bond index JPM Hedged USD GBI Global had 4.3% return with 2.97% volatility and equities index MSCI World had 4.83% return with 15.98% volatility. For more information on SMX, the funds included, and the analysis, visit Symbiotics.
Our conclusion, then, is that while returns on microfinance investment funds may be lower relative to traditional private equity targets they are in the range of other conventional investment opportunities, with potentially lower volatility. We would further note that microfinance has a much more robust track record than most other impact sectors, as explained further below.
Not innovative enough
We have started to hear that impact investors’ work is done in microfinance, and it is now time to devote resources to newer, more “innovative” initiatives, like SMEs, affordable healthcare and alternative energy. We find this surprising and disappointing in at least two respects.
First, the primary hurdle in engaging new investors with microfinance over the past ten years has been the absence of a track record. With microfinance now in a position to present robust performance data, certainly in debt and increasingly in equity, this gap in the record is now largely filled while it remains unfilled in most other impact sectors. Secondly, and more importantly, what we have accomplished to date in microfinance is a comprehensive proof of concept: MFIs can be reliably profitable; can attract the full range of capital providers and offer liquidity; can design products and strategies to both scale financial inclusion and directly target features and causes of poverty. What has not been accomplished is exploiting these capabilities on a global basis to achieve the social ambitions of microfinance at scale. For these ambitions to be realized, the full range of investors must intensify their commitment, rather than step away.
This is in no way to suggest that there is not good and necessary work being done in adjacent impact sectors like the aforementioned. The companies and funds involved in these sectors are often at a nascent stage in grappling with many of the obstacles that microfinance has faced: regulatory challenges, consumer protection mechanisms, and effective integration of technologies. Meeting these obstacles has led to candid introspection on the part of the microfinance industry as well as new advances and innovations that have resulted in more disciplined processes and governance and stronger, more robust institutions which can now serve as platforms, in many cases, for innovating and moving into these adjacent sectors, looking for comprehensive solutions to issues that affect low income/ underserved populations and make their clients better off. As we look for new impact investment opportunities it is prudent to be clear about what needs to be built from scratch and what battles have already been fought and won by the microfinance industry.
Not enough social impact
Another criticism is that with respect to its social objectives, microfinance doesn’t actually work, is mostly hype, and there are much better ways to achieve sustainable economic/social development and poverty reduction. Debate continues over whether the latest crop of randomized control trials (RCTs) proves or debunks microcredit’s impact claims, whether these results shed much light on the impact of microfinance’s broader set of products, and all within the context of a separate debate over whether RCTs are generating meaningful results given their constraints. In large part the debate and disillusionment is, in our view, a manifestation of the maturation of microfinance: a microloan is no longer equated with a family lifted out of poverty. Rather, some MFIs see their role as extending financial inclusion to low income clients within a robust consumer protection framework to support a broadly beneficial process of economic development. Others see solid MFIs as a platform for delivering targeted interventions that directly address nutrition, health, gender or other hurdles that impede opportunity and advancement. That MFIs now pursue a variety of impact strategies and goals is bound to disappoint someone, but we would argue is the most worthwhile use of the resource that microfinance has become.
In Grassroots’ view, then, microfinance continues to offer the most promising platform for generating “impact” in many geographies, either through scaling financial inclusion, delivering complementary or comprehensive packages of support to clients and communities, or serving as a launch pad for piloting initiatives in other sectors. Grassroots and its India-based partner Caspian Impact Advisors are currently engaged with initiatives utilizing all of these capabilities: Prospero (Latin America) and IFIF (India) equity funds expanding financial inclusion; Caspian Impact Investments (India) moving into adjacent sectors; and Grassroots Impact First Investments supporting those microfinance institutions that work hard and successfully to address the issues that inhibit their clients from progressing out of poverty – lack of education, access to healthcare, and the means to build and sustain wealth – but which often struggle to mobilize adequate support from aligned investors.
Microfinance has undergone its share of criticism and self-criticism in recent years. We believe the industry is emerging more focused and more effective in its social objectives and deserves continued support – and continued criticism! – as the leading sector within the broader international impact investing space.