Oswald meanwhile, says: “Pension funds say, ‘we would like to start with $150m’ and we say, ‘not going to happen – you can start with $50m and take it from there’. We have a fund of funds (FoF) which is 80% debt and 20% private equity and we believe the capacity for this fund today is about $500m. We have a private equity FoF and this will raise a maximum of $150m.”
But according to North, this capacity crunch could benefit smaller players: “Your choice is going to be restricted the higher the deal size. There may be an advantage for smaller players who want to choose from things offering higher returns but at lower volume.”
Risk control and motivation
Microfinance advocates say the way to mitigate the risks is to diversify across countries and projects and have a thorough due diligence process, including a legal framework and covenants in place as well as an asset manager with ‘boots on the ground’.
Blue Orchard, for example, invests in projects across 37 countries and limits the maximum exposure a fund can have to one country. “The due diligence process is very labour intensive,” explains Jimenez Davila. “Before any investment into an MFI a Blue Orchard investment officer conducts desk research and at least two days in the field with the institution to carry out on-site due diligence so this is not the type of analysis you do on your Bloomberg at your desk.”
But because of this active management process investors need to be mindful of the fees. For private equity-type vehicles fees can be in the two-and-20 ballpark, whereas debt funds are around 1.5% to 2% depending on the size of the mandate.
“It is about getting comfortable with the risk/return strategy,” says Noelle Laing, research specialist in mission-related investing at Cambridge Associates. “And whether the manager is meeting the characteristics.”
But are investors really seeking to achieve social improvement? Oswald does not think so, saying it is more about accessing growth in these markets. He explains investors want access to the growth story in frontier markets, but without the volatility of listed equity.
“The only way to touch this real economy is through microfinance because it is at the heart of this real economy,” he says. “We see institutional investors very interested in what we do; not for the impact it has – they don’t really care about the impact – but for the access to the real economies of these countries. They don’t get the volatility because it is not listed and they don’t need daily liquidity. They like the fact there is an impact but it’s not a reason to invest.”
However, Waltham Forest Pension Fund chairman Nick Buckmaster says his fund has chosen to look at microfinance mainly because of the social impact. In fact, the fund is in the process of building up an alternatives bucket including a mixture of microfinance and social impact.
“The returns look uncorrelated, stable and look to be about 7%,” says Buckmaster. “You have more chance of getting a consistent return [with microfinance] than getting your council tax paid. The returns of money invested are around 98% and it has a Sharpe Ratio of 3, which stood out immediately. It made business sense and social sense, although that is not the priority. It was a good idea and we wanted to embrace it.”
Yet it seems the UK market is yet to embrace microfinance. This could be due to a lack of knowledge or because domestic investors prefer domestic projects. Either way, if investors are able to see past the illiquidity, capacity, political and governance risks, they might just see impressive returns.
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