* Funds see microfinance as way to diversify
* Microfinance firms have shown strong relative performance
* Political, correlation risks remain
By Eunice Ng
LONDON, Aug 2 (Reuters) - Microfinance and its goal of helping people escape the poverty trap is starting to draw mainstream investors who, ethical cudos aside, are lured by its inherent insulation from global financial trends.
Microfinance schemes involve loans of a few dollars to some of the world's poorest -- long treated as unbankable -- allowing them to grow their businesses by things as simple as buying better seeds or fertiliser or expanding street stalls.
From a modest beginning 30 years ago, the sector has ballooned in the last decade, particularly since Bangladeshi microfinance pioneer Muhammad Yunas won the Nobel Peace Prize in 2006.
But once the purview of development charities, now hard-nosed mainstream investors are getting involved. From 2005 to 2009, MIV assets grew to $6 billion from $1.2 billion, according to microfinance rating agency Microrate.
The world's poorest might struggle to feed themselves on a daily basis, but they have proved surprisingly reliable at repaying their loans. Their position at the bottom of the global financial pyramid also means that while they might be vulnerable to local shocks such as floods and riots, their businesses are less correlated to official monetary policy and the ups and downs of global markets.
"Investors come in because they think it is good diversification. (Microfinance is an) asset class that has different drivers than other asset classes ...and doesn't react to shocks in the same manner," said Jean-Pierre Klumpp, CEO of BlueOrchard, a microfinance investment company.
The steady growth in investment interest has been remarkable during one of the most turbulent periods for developed world finance and the global economy in 60 years.
Big institutional investors such as pension funds, acting mostly through Switzerland-managed microfinance investment vehicles (MIV), are starting to look at this specialist area as a viable long-term asset class.
Microfinance institutions lend small sums to large numbers of borrowers, but for each loan, interest rates are relatively high, a key reason why the sector is appealing to institutions.
BETTER BOUNCE BACK
So how has microfinance performed relatively for anyone who locked into it several years ago?
A study from think-tank Consultative Group to Assist the Poor (CGAP) showed JPMorgan's Low Income Financial Institutions index, which consists of four microfinance institutions that went public in 2007 and measures publicly-traded stocks of banks servicing low income clients, would have outperformed global equity indices by more than 700 percent from 2003 to 2009.
While the index did plummet alongside other world bourses and emerging financial stocks as the credit crisis triggered a world recession, it has more than recovered those losses and investments made in 2007 would be back in the money.
By contrast, despite a recent rally neither the MSCI world index nor its emerging market sub-component have made it back to their late 2007 peaks.
A CAUTIONARY NOTE
Yet even microfinance cannot insulate itself completely from the dominant global trends.
MIV growth slowed during the financial crisis, growing only 22 percent in 2009, compared to the 97 percent growth seen in 2007, according to Microrate.
The survey also noted that less than half the MIV funds actually reached microfinance institutions. The global financial crisis put a stop to the industry's frenetic growth, and consequently institutions stopped asking for funding.
Ironically, as institutional investors show an increasing interest in the sector, bringing it more in line with the global financial system, microfinance is at risk of losing its attractiveness as a diverse asset.
"The industry cannot be completely de-correlated," said Christian Speckhardt, a member of the management board at responsAbility, a social investment company.
Political and social risks also remain extremely high.
A good example is Nicaragua, a country which has one of the more mature microfinance industries. By late 2008, an economy that was already facing shrinking remittances from the United States turned on microfinance, saying its interest rates were exorbitant. Borrowers defaulted en masse and some even tried to burn down a microfinance office.
"If a microfinance country would go into a prolonged war situation or a serious political unrest - these are situations that can have a significant impact on the local microfinance industry," added Speckhardt.
(Additional reporting by Peter Apps; editing by Patrick Graham)
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