The Microfinance story
Microfinance seems to be the latest buzz word in the world of investments – but what is microfinance, how does it work and how can it benefit investors?
What is microfinance?
Microfinance is the provision financial services and in particular loans to help entrepreneurs in the developing world grow small businesses.
- Loans tend to be low value, ranging from £100 - £1,000 but sufficient to help grow a business opportunity
- Finance from traditional banks is not generally available to these people
- The majority of borrowers are women which tends to reduce the level of defaults
What are the financial returns?
When run by an experienced fund manager, microfinance has the potential to deliver strong, stable returns:
- Thorough due diligence on microfinance institutions ensures that lending policies are rigorous and controlled
- Local market knowledge results in low default rates even compared to mainstream lending in developed economies. Lenders report repayment levels in excess of 97% as the norm
- Investment limits imposed by country, currency and microfinance lender provide diversification and avoid overexposure in any given market
- Prevailing interest rates in developing nations are often high, producing high returns whilst still providing an important social service
- The businesses that are created often serve the local community and tend to be less affected by downturns in the global economy
A new asset class for the investor
Research to date indicates that investment returns tend not to go up and down in line with stock markets in the developed world*. As a result:
- Microfinance is potentially a good balance to traditional investment vehicles such as UK equities
- Microfinance can reduce volatility of an investment portfolio by providing a valuable hedge when other traditional assets are falling in value
What is the social impact of microfinance?
- Providing loans to people who would not be able to access finance
- Creating small businesses in the developing world
- Increasing employment through job creation
- A powerful and effective tool for lifting individuals, their families and communities out of poverty
Microfinance is not suitable for every investor
Providing finance in underdeveloped countries which may lack a strong commercial infrastructure; often making the loan in local currencies into unproven business opportunities must clearly carry a significant element of risk. Certain microfinance funds that Truestone have access to would only be suitable to 'sophisticated investors' who can demonstrate that they fully understand the risks associated with this type of investment.
It is important to seek professional, independent advice when considering this type of investment. For a suitable investor,Truestone recommends that only a small proportion of any portfolio should be invested in microfinance.
The Financial Services Authority does not regulate some forms of microfinance arrangement.
*Nicolas Krauss and Ingo Walter 2006 research commissioned by Developing World Markets
