The Retail Investor’s Guide to Microfinance

Key Takeaways

• Since the movement’s founding in the 1970s, with the goal of alleviating global poverty, microfinance has provided millions of individuals in poor communities services and loans meant to enhance their livelihood, and ultimately, life quality. 

• Microfinance services seek to heighten access to savings accounts, loans, fund transfers, small credit lines, and insurance, which offer opportunities for recipients to grow and become more stable.   

• Microfinance can offer investors diversification benefits that are in demand — due to their low correlation with public markets — particularly during periods of economic slowdown or instability.

You know that phrase, “Doing well by doing good”? It is certainly applicable to microfinance, which allows investors to add value to their portfolio – as well as to the world. Such investments can provide solid returns while making a real difference in underserved communities. To cut through the complexity associated with them, here is the retail investor’s guide to microfinance.

Microfinance

Increasingly, retail investors are interested in microfinance, a term used for the suite of financial services for those who lack access to traditional banking. 

More than 31% of adults globally are deemed “unbanked.” Common reasons for such status include socioeconomic factors such as poverty or a lack of education, lack of access to a nearby bank branch, lack of assets to serve as collateral, distrust of the banking system, or minimum opening balance.  

Microfinance services, which are offered to individuals, small businesses, or entrepreneurs, seek to heighten access to savings accounts, loans, fund transfers, small credit lines, and insurance, which offer opportunities for recipients to grow and become more stable.   

One can also invest in microfinance through equity, debt, and funds. Such investments generally have a dual nature: financial returns as well as social Impact.

What is Microfinance Investment?

According to BlueOrchard, more than 55,000 people can be helped by a five-year investment of $1 million.

However, prospects of favorable social impact should not blot out financial diligence and investment returns. A microfinance model, after all, is reliant upon its long-term viability for investors. Microfinance needs to work for investors – those lending the capital. 

The fact is that the prospects for competitive and stable returns, in addition to low default rates, are luring more and more investors who like the idea of achieving market returns while doing good – helping to reduce poverty and increasing financial inclusion and the like. 

What is more, microfinance can offer investors diversification benefits that are in demand, due to their low correlation with public markets, particularly during periods of economic slowdown or instability. Such portfolio benefits will be discussed in more detail later.

Overview of the Microfinance Market

Despite higher interest rates and generally shorter repayment terms, the worldwide microfinance market was valued at nearly $179 billion in 2020 and is expected to reach more than $496 billion by 2030.  

Increases in the number of microfinance organizations help developing nations reduce poverty and improve standards of living.

Commercial Banks vs. Traditional Banks in Microfinance

Commercial banks profit by earning interest from loans including mortgage, business, auto, and personal. The capital to make such loans derives from customer deposits. Such loans generally require good to excellent credit and have inflexible repayment terms.

Meanwhile, microfinance institutions, which seek to cultivate deep roots in their communities, operate within a regulatory framework and generally offer more lenient standards and flexible repayment terms, but with generally higher interest rates. They also achieve low default rates with their underwriting methodology. 

As the desire for socially responsible investments keeps growing, large, commercial banks such as J.P. Morgan are seeking to fortify connections between global capital markets and impact investors.

Financial Inclusion Through Microfinance

The impact of microfinance on financial inclusion, which emphasizes socio-economic development, can ultimately mean financial freedom and economic agency for all, with the eradication of worldwide poverty a chief aim.  

The potential benefits of microfinance can include heightened household wealth; more than 97 million individuals globally live on less than $2 daily. More money creates opportunities for others, better family health and education, sustainable means of assisting low-income populations, and narrowing of the gender gap, as many microloan recipients are women business owners.

Since the movement’s founding in the 1970s, with the goal of erasing poverty, microfinance has provided millions of individuals in poor communities services and loans meant to enhance their livelihood, and ultimately, life quality. 

Financial Returns of Microfinance Investment

For many, investing in financial inclusion represents an attractive business opportunity. After all, microfinance can prospectively have a favorable impact in areas that greatly need it, along with attractive financial returns and relatively low default rates.

Repayment Rates and Risk Assessment

Collateral is rarely required in microfinance agreements. Because of that, interest rates on microfinance products can vary based on the lending situation and the risk of providing a collateral-free financial product. Overall, though, rates are often higher.

Some lenders require borrowers to set aside part of their earnings in a savings account they can utilize, should the borrower default, as insurance. Other bankers try to protect against risk by combining borrowers, who repay the loan collectively. 

In terms of risk to retail investors, note that the default rate for the microfinance sector tumbled to 5.3% in 2022 from 16.7% the year before. 

How to Invest in Microfinance for Retail Investors

There are a few ways retail investors can invest in microfinance, including by:  

• Direct investment in microfinance institutions (MFI)s: While permitting investors to adopt a social investment strategy aimed at alleviating poverty, MFIs simultaneously provide an attractive risk-return profile. 
• Investing in specialized microfinance funds: The main benefits of taking positions in such funds are diversification and risk mitigation. Such funds offer exposure to a diverse set of impact and micro finance institutions.
• Peer-to-peer lending platforms: Such platforms offer easy accessibility and lower investment thresholds.

Examples

Here are a couple of examples of how microfinance is used:

• James, a corn farmer in Kenya, took out a microfinance loan for $125, which he used to buy and plant better-quality seeds, resulting in an improved harvest and higher earnings. James will reinvest the extra capital in his farm for another growing season.  
• Here is an example of how microloans can have a broader, societal impact: Linda, who owns a cereal company in Rwanda, buys raw grains from 3,500 small farmers traversing the region and processing them for sale in her modest market and to wholesalers. She used a $35,000 loan for a new truck to ferry more grains from even more farmers. This allowed her to grow her business and add more employees.  
• As for retail investors in the microfinance sector, a $175 million, J.P. Morgan-led deal for Swiss investor responsibility to ultimately boost lending to female entrepreneurs in developing nations. The deal allows retail investors to gain access to microfinance social-impact markets.  

Considerations for Retail Investors

Retail investors in microfinance should understand the social and economic context of their investments. After all, microfinance can potentially address global issues such as inequality, poverty, and environmental damage, but investors should gain specifics regarding the MFI’s planned impact.

Still, microfinance investments should be made based upon the investor’s risk tolerance and investment time horizon, and after performing due diligence on prospective investments.

Potential risks include the lack of an MFI formal policy on multiple loans, lack of transparency regarding financial products’ prices and terms, and the lack of a formal mechanism for handling customer complaints.

Also, past performance is not a perfect predictor of future performance and may not again occur. But then, that is true for all investments.

Other Investment Options for Retail Investors

Beyond microfinance, there are other ways retail investors can add value to their holdings, including through alternatives – essentially asset classes other than stocks and beyond.

Take one of the leading alternative investment platforms, Yieldstreet, on which $4 billion has been invested to date, with accessible minimums and a variety of asset classes. Such private-market alternatives, which include art and real estate and more, are increasingly popular among investors wary of the volatility of public markets. These assets offer lower correlation to the stock market.

Alternative assets – Yieldstreet offers the broadest variety available – can potentially provide steady passive income as well as portfolio diversification – holdings that comprise varying investment types. The investment strategy can mitigate overall portfolio risk and prospectively improve returns. 

Alternative Investments and Portfolio Diversification

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as  $10,000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Microfinance investments offer the dual benefit of financial and social returns in what is a growing market. In fact, signs generally point to a bright future for retail investments in microfinance, and there are ways to participate that align with one’s investment goals and personal values.