The Role of Equity Funds in Microfinance IDB Forum on Financing MFIs Santa Cruz, Bolivia September 2005 Elisabeth Rhyne Senior Vice President ACCION International

Why Equity is Different 1.Equity is risk capital. It assumes the fundamental risk of an organization. 2.Equity provides the basis for capital adequacy. 3.Equity involves investors as owners of an organization. As such: 4.Equity provides the confidence regulators to grant licenses. 5.Equity provides the confidence creditors and depositors need to put their money into an organization. 6.Equity is necessary for growth.

Who Invests in/Owns MFIs? According to CMEF study of 18 MFIs, equity investors into MFIs include: Founding NGOs (local) – 6 International private equity funds (mainly international) – 15 Multilateral and bilateral development banks (mainly international) – 12 Private socially responsible investors (mainly international) – generally through private equity funds Private commercial investors (local and international) – 11 Managers and staff (through ESOPs) (local) – 2 Individuals and other NGOs (local and international) – 6 Most MFIs have between 3 and 8 shareholders

Scale of Shareholder-Owned MFIs RegionNo MFIsAssets (Mn.) Loans (Mn) Clients (‘000) Equity (Mn. LAC47/351, EEUR25/ Asia24/ ,07848 Africa & ME 28/ Total124/922,4911,5492,896363

Portfolio Size of Latin American MFIs

Equity in Latin American MFIs

No. of Clients in Latin American MFIs

Private Equity Funds Examples: Profund, ACCION Investments, Gray Ghost, ShoreCap, Africap, Triodos, DID, etc. Size -- $15 -- $20 million (GG -- $50 million) Size of investment in MFI – $200,000 - $2 million Source of funding – public development banks; socially responsible investors New funds: Bellwether, Oikocredit, etc. Life span – 10 year funds vs. open-ended companies Motivation: social and financial return: DBL

Types and Origins of Equity Funds Independent equity funds specialized in microfinance: Profund and AfriCap Funds linked to microfinance networks: ACCION Investments, ACCION Gateway, Opportunity International, Desjardins and ShoreCap Funds created by private socially responsible private investors with an interest in microfinance: Gray Ghost, Unitus and Andromeda European funds with special connections to smaller investors. Some of these are primarily debt funders and have recently added equity: Triodos, Oikocredit, responsAbility, SIDI Non-specialized foundations with an interest in microfinance: Calvert and Open Society Institute

Who Do They Invest In and Why? To attract equity investment, MFIs must be: Profitable and solvent Good market position, growth potential Strong management and governance Transparent about financial condition Licensed or about to become licensed Acceptable ownership structure: like-minded group Operating in country with reasonable business environment Equity investors are looking for both DBL returns and influence in return for taking risk and responsibility for the MFI.

How Are Equity Funds Structured? MFI Fund Fund Manager Private Individual Multilateral Bank Foundation Bilateral Bank Sponsor

What Drives Them? Returns. Return to investors filters out 1) fund management costs and 2) foreign exchange risk. ROE of 6-12% desired. Social goals. Generally satisfied by investing in MFIs. May have special concerns/limitations/philosophy Industry development. Attracting private capital into microfinance Influence. Ability to participate in governance, bring added value Exit. Need to get out in middle distance Prudential responsibility to investors

Issues of Concern to Equity Investors Deal Flow. Too much money chasing too few deals? Is public money crowding out private? Is international money crowding out local? How can the pool of investment-ready MFIs be increased? Any empirical evidence?

Issues of Concern: Monitoring Social Performance Two levels, each requiring different tools: In governance of MFIs, ensuring social performance monitoring is being implemented – indicators tailored to MFI mission. –Poverty level of clients –Client retention and satisfaction –SOCIAL score To report to investors into the equity funds – simplified standard indicators. –TBL (triple bottom line), PPP (people profits planet), MDG (millenium development goals) –Gray Ghost’s index of social performance by investment

Issues of Concern: Governance Agreeing on an appropriate balance between social and financial goals. Working effectively as minority shareholders. Protecting minority rights, and forming effective shareholder groups Balance between management and board; avoiding management capture of governance. A particularly sensitive issue is how to compensate management. Commonly accepted standards for: conflict of interest, board member compensation, use of independent directors, etc.

Issues of Concern: Risk and Return Viability of funds depend on fund size and management costs -- in turn restricting size and type of investments that will be profitable Increasing leverage ratios among investee MFIs for higher ROE Country risk and foreign exchange risk: most serious source of losses for equity investors Thin market makes it difficult to value investments for sale Difficulty of exit – and exit to whom