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Financial Times – Pension funds turn to low-risk microfinance

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Pension funds turn to low-risk microfinance

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By Kate Burgess

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Published: October 8 2009 18:00 | Last updated: October 8 2009 18:00

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Microfinance – where financial institutions back tiny start-ups and would-be entrepreneurs in the poorest parts of the world – is little more than a gleam in the eye of most of the world’s biggest banks. But it is the one area of subprime lending that still has a reputation for being relatively low risk in spite of the financial crisis and is attracting new investment.

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Some of the world’s biggest pension funds have increased their investments in microfinance this year and expect to raise it further in the next few years.

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Analysts estimate that the microfinance industry in its entirety has somewhere between $30bn and $60bn in assets compared with, say, Royal Bank of Scotland which alone has assets of $3,500bn. Pension funds have so far invested about $3bn, according to a report by the World Microfinance Forum in Geneva.

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But investment is rising. The latest fund to lift its commitment is PGGM, manager of the €70bn ($103bn) Dutch healthcare industry pension fund, which is committing €200m to microfinance, making it one of the largest allocations to the sector.

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This summer it invested $60m and became a corner stone investor in Grassroots Capital, a private equity style fund that takes stakes in microfinance institutions.

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ABP, one of Europe’s biggest pension funds with about €180bn in assets, has invested $180m in microfinance and says it has raised its commitment by $40m this year. It expects this commitment to rise again in the next few years.

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TIAA-CREF, the US manager of retirement schemes with $374bn in assets, meanwhile, promised in 2006 to invest $100m over four years. The draw for these schemes is that microfinance has paid out returns as high as 20 per cent a year while fulfilling an aim to lift households out of poverty.

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Alex van der Velden, PGGM’s head of responsible equity strategies, says the MFIs of today will be the emerging market banks of tomorrow. “In many emerging markets, microfinance is the normal form of financing. It is the only way of lending to the bottom of the pyramid and is growing enormously quickly. And it helps from a risk diversification basis. Returns from microfinance have been less volatile than other fixed-income investments.”

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Microfinance started nearly 40 years ago when Muhammad Yunus, lent $27 to a group of women in Bangladesh making bamboo furniture. Until then traditional banks had been loath to fund such tiny operations, fearing high risk.

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But Mr Yunus, who founded Grameen Bank, and economists found these groups were mostly good credit risks, paying back loans fast and often borrowing more to expand. Lending institutions – non-governmental organisations, local co-operatives and banks – found lending to these people was good, repeat business. Moreover, MFIs helped to improve standards of living, transforming and empowering marginalised groups, particularly women, in some of the worst slums and ghettoes in developing markets.

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By 2006 it was estimated 90m people were borrowing from MFIs to fund cottage industries and embryonic businesses. Now funds such as Grassroots have been set up to fund the MFIs.

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There are still sceptics and the WMF in Geneva reported that European pension funds worried the industry was too small to make a difference to returns while being expensive and time-consuming to manage. Recent studies suggest the social benefits are less clear than earlier reports supposed, and cynics say that while giving households access to loans may help people into employment, microfinance is too small ever to lead to mass alleviation of poverty.

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Others point out that annual interest rates on loans at, say, 30 per cent are still high. But Mr van der Velden says: “Microfinance institutions are seen as an antidote to loan sharks. They introduce competition to loan sharks, driving down interest rates. It will be an asset class of significance in the years to come. If we wait to invest, by the time it is mainstream, we will have lost most of the opportunity.”

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Copyright The Financial Times Limited 2009.

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