Blended Value Investing

World Economic ForumMarch 2006

Blended Value Investing: Capital Opportunities for Social andEnvironmental Impact

COMMITTED TO IMPROVING THE STATE

OF THE WORLD

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REF: 270306

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Contents

Preface 5

Organization and Conclusions 6

Innovations in Debt Financing:Advances in the Fields of Microfinance and Community Development 7

Introduction to Microfinance Debt Offerings and Securitization 7

Access to Capital Markets 8

Microfinance Bonds and Securitization: A Primer 9

First Case Study: ACCION International’s Domestic Market Bond Offerings 11

Second Case Study: Global Partnerships’ International Debt Offering 14

Emerging Issues in Microfinance Securitization 18

A Note on other Debt Financing Innovations 21

Third Case Study:Community Investing, Media Development Loan Fund, and Calvert Social Investment Foundation 21

Credit Guarantees and Enhancements:

Flexible Catalysts for Blended Value Investment 27

First Case Study: Nurcha and the Open Society Institute 29

Second Case Study: Deutsche Bank Microcredit Development Fund 32

Third Case Study: MicroCredit Enterprises 33

Fourth Case Study: Grameen Foundation USA’s Growth Guarantees Programme 36

Fifth Case Study: Global Commercial Microfinance Consortium 37

Innovations in Private Equity Investing 42

Introduction 42

Variations on Traditional Venture Capital 44

First Case Study: ACCION International’s Domestic Market Bond Offerings 45

Second Case Study: Aavishkaar India Micro Venture Capital Fund 49

Third Case Study: ShoreCap International and ShoreCap Exchange 51

Fourth Case Study: Actis 53

Building Blended Value Portfolios 56

A Cautionary Conclusion: Maximizing Blended Value Returns by Embracing Market Fundamentals 59

Appendix A: Other Notable Developments in Microfinance 70

Appendix B: A Glossary of Blended Value Investing Terms 72

Acknowledgements 74

Endnotes 75

5Blended Value Investing: Capital Opportunities for Social and Environmental Impact

The World Economic Forum is pleased to issue thisreport, which seeks to explore how “Blended ValueInvesting” (BVI), as distinct from either market-rateinvesting or philanthropy, can leverage economicperformance while also creating social and/orenvironmental value within a single, unifiedapproach to investing and capital finance.

BVI is, by definition, a market-based approach toaddressing many of the challenges facing theglobal community. BVI seeks to engage capital increating sustainable, long-term solutions to thosesame challenges. Such strategies are defined as“blended value” and not “double bottom line” orphilanthropy since they view the value beingcreated as neither solely economic nor solelysocial, but a blend of both. This approachrecognizes that economic value can create variousforms of social and environmental impact andcannot be viewed as a separate component of thevalue proposition found within any giveninvestment. Therefore, BVI seeks not a doublebottom line, but rather a single bottom line withmultiple value components.

In September 2004, the World Economic Forum’sGlobal Foundation Leaders Advisory Group hostedan international meeting of investors, foundationexecutives and representatives from non-governmental organizations to discuss the state ofblended value investing and explore what barriersexist to expanding the use of private capital forsocial gain. Private Investment for Social Goals:Building the Blended Value Capital Market waspublished by the Forum in 2005 and presents thekey discussion points and findings from thatsession.

At the conclusion of the 2004 meeting and follow-up discussions during the World Economic forum'sAnnual Meeting in Davos in 2005, sessionparticipants requested that a research project beundertaken during 2005 that could explore ingreater detail how a variety of capital financestrategies are being applied to the area of blendedvalue investing. Furthermore, since the arena ofmicrofinance is viewed by many as an excellent

example of how economic and social value may beleveraged through investment innovations, participantsasked that this research also summarize currentpractices in microfinance that might inform investingactivities in other related areas.

In fact, many of the examples presented in thisdocument are taken from the field of microfinance andcould be applied more broadly to other areas ofinterest, whether housing, local building projects,small/medium enterprise development, healthcare,education or beyond.

We wish to thank Cisco Systems Foundation formaking this project possible, Jed Emerson of theGeneration Foundation and Joshua Spitzer for draftingand researching the report, and the members of theForum’s Global Foundation Leaders Advisory Group forproviding comments and overall guidance. We alsowish to thank Adele Simmons, Senior Adviser to theForum, and Sam Mbugua, Global Leadership Fellow,for their support of the project.

The World Economic Forum’s efforts at catalyzing andsustaining the important debate around Blended ValueInvesting have received support from many quarters. Ingratefully acknowledging these contributions, bothfinancial and intellectual, we also look forward to thepositive evolution of this discussion and to theexpanded application of creative investmentapproaches that can accelerate progress on pressingsocial and environmental problems.

Richard SamansManaging DirectorMarch 2006

Preface

6 Blended Value Investing: Capital Opportunities for Social and Environmental Impact

Organization and Conclusions

This paper is organized into three inter-relatedsections, each with case studies presenting detailson the process of innovation within the blendedvalue investing arena.

The first section explores innovation in debtfinance. It has two subsections. The firstsubsection presents the process by which loans tomicrofinance institutions are “packaged” as financialsecurities that offer the opportunity to expand thecapital available to such funds. Thesedevelopments serve as examples of what couldtake place in other emerging areas of investing. Thesecond subsection explores another novelapplication of debt finance applied in the realm ofcommunity investing, which further investigateshow blended value investing strategies can bemade accessible to individual investors.

The second section presents cases in which creditguarantees and enhancements have been usedto manage the risk (perceived and real) associatedwith various blended value investmentopportunities. In several cases, suchenhancements helped other investors price riskmore accurately so that ultimately capital could flowmore freely to those investments.

The third section presents private equityinvesting innovations, which provide risk capitalto new funds and enterprises that generate bothsocial/environmental impacts as well as economicvalue and returns.

Those attending the discussions at the Forum inGeneva asked that several of the anecdotal storiesof participants around the table be broughttogether and formally presented to othersinterested in understanding more about:• How these deals evolved;• The challenges of structuring them;• The possible prospects such investing practices

hold for broader application by others interestedin creating innovations in capital finance.

This paper is offered not as a fully comprehensivesurvey of the emerging area of blended valueinvesting, but rather as a set of examples of howsuch investing practices are being developed andapplied around the world. The paper’s intent is notto provide a single answer for all investmentchallenges, but to demonstrate how groups ofinvestors are mobilizing capital on new terms tomeet the challenges of emerging investmentopportunities, as well as the demands of investorsseeking out new asset classes in which to placetheir capital.

While the paper presents part of the history ofgroups and individuals who have worked toadvance these practices, it is does not present ahistory of the field or a comprehensive overviewand should not be taken as such. Otherdocuments by CGAP, ACCION and related groupsshould be sought out by readers looking tounderstand how, specifically in the area ofmicrofinance, various instruments and approacheshave evolved.

This paper presents innovations in capital financethat promise to bridge market-rate interests withstrategic opportunities to create blended value thatbenefits shareholder and stakeholder alike. Thefollowing examples speak to an evolving capitalconvergence wherein mainstream capital marketsand investing will increasingly become drivers ofnew solutions to historic problems. Blended valueinvesting funds and instruments offer financingstrategies from a set of tools that go beyondtraditional philanthropy or market rate investing andwhich complement the vision we all share of aworld with greater equity and opportunity for itsmembers.

This paper also identifies several areas of researchthat would help advance the field of blended valueinvesting. In summary, those projects include thefollowing:• An in-depth survey of blended value investors

that would ultimately segment the market andidentify strategic investor groups and categories;

• An inquiry into blended value portfolio theory tounderstand how investors have applied modernportfolio theory concepts and analytics tobuilding diversified blended value portfolios;

• A deeper inquiry into applying lessons learnedfrom microfinance to other blended valuesystems.

Finally, the paper concludes with words of cautionthat suggest a prudent approach to developingblended value capital markets. It offers a critique ofthe state of the markets, presents a strategic visionfor the blended value capital markets, andsuggests specific steps that participants might takein moving toward the ideal.


Fortunately, a growing number of microfinanceinstitutions possess the business fundamentalsnecessary to access those capital markets. Beforecommercial capital may fund the microfinanceindustry on a large scale, capital markets willrequire investment products capable of meeting theneeds of both microborrowers and investors ofcapital. This section examines several verypromising early examples of these products, whichmay represent the path toward a suite ofinvestment instruments offering truly blendedreturns that maximize social and financial value.

The Microfinance Success Story

In the thirty years since the Grameen Bank,ACCION and other MFIs showed the rest of theworld that small loans to poor women coulddramatically improve the lots of families andcommunities, microfinance has become a widelycelebrated model of economic development. Manysources document the growth of the sector overrecent decades, and this paper’s Appendix Apresents a brief review of key microfinanceinnovations. Those innovations have mademicrofinance securitization possible. Much of thissection explores how securitization has openednew options to capitalize on and invest in bothfinancial performance and social impact.

Among many blended value investing strategies,microfinance is one of the most mature. Itssustainability and replication have introducedinnovations that are not only enhancing thefundamental value proposition of microfinance, butnow appear applicable to other blended valueinvestment programmes. These innovationscontinue to bring microfinance to new levels oflarge-scale efficacy, and may eventually findapplication in other areas in order to bring thoseareas to a similarly substantial scale. Since otherpublications have explored the current state of thefield, this section will not examine the overall stateof the microfinance industry.1 Though the sectionwill discuss several innovations in the sector, morecomplete explorations of those innovations can befound in other sources cited later in this text.

The following narrative examines the structure andactors in several microfinance securitization deals,delving more deeply into one particular deal to offerlessons learned and help identify emerging issuesassociated with successfully securitizing debt toMFIs.

Introduction to Microfinance DebtOfferings and Securitization

Many blended value investors’ primary goal is toachieve real social returns together with financialreturns that are not concessionary to the risk-adjusted rate investors could otherwise attain.Investments meeting that goal would be fairly easyto trade and have investment terms that areunderstood by the average investor. Suchcharacteristics would generate significant demandfrom all sorts of investors—especially those who donot now take account of how they might createblended value in making capital investmentdecisions. For these reasons, the practice ofsecuritizing loans to microfinance institutions (MFIs)is a very promising prospect for many involved inBVI.

Built on hundreds of millions of dollars in donatedand concessionary-rate (which is to say, belowmarket rate) capital, microfinance has proven to bea sound and powerful investment in blended value.However, despite wide-spread growth inmicrofinance around the world, the industry hasnow reached a critical point: many funds have lentall or most of their available capital; they musteither sell some of the debt on their balance sheetsor otherwise secure substantial new funds in orderto expand their lending activity.

Those investing philanthropic capital for socialreturns have supported microfinance institutions inbecoming viable, in proving that poor people makegood customers for financial services, and inreaching a remarkable scale. Nevertheless, the sizeof the microfinance industry has the potential to bedramatically larger, and philanthropic capital alonewill not be sufficient to achieve this potential. Toextend microfinance to a substantial majority of theworld’s poor, a new kind of capital must enter thismarket, and that capital will most likely come fromthe mainstream capital markets, where the majorityof funds are currently invested without regard forsocial or environmental returns.

Innovations in Debt Financing:Advances in the Fields of Microfinance and Community Development


Direct Lending to MFIs

Investors with sufficient scale and knowledge of thesector may loan funds directly to MFIs (often on aconcessionary rate basis, and foundations canstructure such capital as programme-relatedinvestments). Nevertheless, there are limits to theeffectiveness of these lending practices. Suchlending is difficult to scale and offers only limitedaccess to mainstream capital markets. Each loanrequires a separate due diligence process, which,in the case of direct lending, is not leveraged overmany investors. Diversification is very difficult andrequires considerable investment scale (i.e., theinvestor must initiate several direct loans to variousMFIs, each requiring a separate due diligence andinvestment process). Furthermore, once such loanshave been made, they cannot easily be transferredor exited. Accordingly, such lending practices tendto be limited to the few institutions that have deepknowledge of microfinance and have made aninvestment commitment to the sector. In truth, thisstrategy is not likely to attract mainstream capitalflows.

In response to the various limitations of directlending practices, a number of actors in the MFIarena have begun exploring how intermediariescould work to aggregate loans to MFIs and provideaccess to more mainstream capital by creatinginvestment vehicles with greater market appeal andavailability to mainstream investors. Such productshave a variety of features:• They can offer investors a measure of broader

diversification; • They can leverage due diligence and similar costs

across multiple investors; • They offer potential investors a standardized

product with attributes that are familiar to them; • They have the potential to be transferred.

Driving the increasing scale of microfinance(engendered by replication, the growth of MFInetworks and improved transparency) is atremendous demand for microloans—and anequally large attendant need for capital. JenniferMeehan, Director of Capital Markets, GrameenFoundation USA, explains:

Some MFIs have scaled dramatically to achievegreater coverage. For example, Meehan reportsthat the number of Grameen Bank clients grew atan annual rate of 33.7% between 1983 and 1996,while the bank’s portfolio grew at an exponentialrate while maintaining its high quality. GrameenFoundation USA estimates that ten percent of apotential US$ 300 billion microfinance market hasbeen penetrated. In order to approach thatpotential or even to grow appreciably, Meehanindicates that philanthropy alone will remaininadequate:

Individuals and institutions wishing to financemicrolending can provide capital to MFIs directly, orinvestors can syndicate their capital, forming fundsor other investment instruments that can share riskand invest in multiple MFIs. Whether they areinvesting directly or through funding intermediaries,microfinance investors can deploy their funds infour ways:1. Donate to an MFI (and any number of reputable

programmes for doing so can be found withlittle effort);

2. Leverage assets through loan guarantees toMFIs (an investment vehicle addressed inSection Two of this paper);

3. Purchase MFI equity; 4. Loan money directly to MFIs.

Thus far debt investments have shownconsiderable promise and, after donated funds,make up the bulk of capital that has flowed toMFIs. The following section describes a range ofapproaches to debt investments in MFIs.

Access to Capital Markets

“Around the globe there are 2.8 billion people, approximately 560 millionfamilies, who are considered poor, living on less than US$ 2 per day inpurchasing power parity (PPP). Of those, 1.2 billion people live in abjectpoverty; the ‘poorest’ surviving on less than US$ 1 per day PPP. Despiterecognition of microfinance as a proven poverty reduction tool, fewer than 18%of the world’s poorest households have access to financial services.” 2

“Despite the important and catalytic role played by theinternational donor community in promotingmicrofinance, it has invested only US$ 1.2 billion in thesector and allocates an incremental US$ 800 millionto US$ 1 billion per year in new financing." 3

Microfinance Bonds and Securitization:A Primer

9

This paper assumes that the reader comes to thisdiscussion with an introductory level of knowledgeregarding this area of capital finance. The followingsection is offered to ensure a shared baseline offamiliarity with the concepts in order to help thereader make the most of the examples that follow.

Securitization Defined

Securitization in general refers to pooling manyfinancial assets and “packaging” them as newsecurities that can be purchased and sold byinvestors unable to invest in each fund individually.Most commonly, loans are aggregated into notes,the cash flows of which are provided by manyunderlying loans. Housing mortgages arecommonly so packaged by investment banks. Thepractice has been extended to all sorts of debtinstruments, including credit card receivables andcar loans.

The following example of mortgage-backed bondsillustrates the securitization process.

The microfinance capital markets are approachingsecuritization as a means of bringing more funds tomicroentrepreneurs. Most of these investmentstructures cannot, strictly speaking, be consideredsecuritizations, though they have many features ofthat type of asset. In most of these examples,securities are sold to investors and the proceedslent to MFIs. Cash flows to bond investors arederived from payments being made on existing andnew microloans to MFI clients. Unlike themortgage-backed securities described in theexample above, most MFI bond offerings have notbeen linked directly to specific, individual loans.Instead, they are structured as obligations of the

MFIs, which, in turn, are supported by theindividual loans made to microentrepreneurs. Assuch, the microloans stay on each MFI balancesheet as loans receivable, and the MFIs alsoundertake financial obligations that they mustrecord on their balance sheets as notes payable. Asecuritization (in the technical sense) would enablethe MFI to bring in cash without increasing its ownliabilities (though in doing so, the MFI would needto sell the loans receivable). Increasing cashwithout increasing liabilities, as is the case withsecuritization, allows the MFIs to loan more moneywithout raising additional equity to meet capitaladequacy requirements.

Loan Tranches

Many loans are structured in multiple layers,referred to as “tranches.” Each tranche is a set ofsecurities that has a particular risk-reward profileand is then marketed to investors seeking that typeof investment opportunity. The most seniortranches are the safest, that is, they are first in lineto receive cash flows from the underlying loans.Consequently, they bear a lower interest rate thanthe more junior tranches. The junior tranches’ cashflows are only passed through to investors whenthe senior tranches have been paid. Any defaults inthe underlying loan portfolio are assigned to themost junior tranches first. These junior securitiescarry a higher interest rate in exchange forassuming greater risk exposure associated with thischaracteristic.

The ability to offer multiple tranches has been anessential feature of the more sophisticatedmicrofinance debt issues to date. Those structuresallow investors to purchase securities with the risk-reward profiles best suited to meeting theirinvestment needs. In the existing deals, the verymost junior tranche is called an equity tranche. It istermed such because the cash flows are sounpredictable that they cannot be assigned acoupon rate (namely, a fixed rate of return aninvestor receives when participating in any givenround). The equity investors have a residual claimon cash flows after all of the other investors havebeen satisfied. Such investors will not know thereturn on their investment (if any) until all of theother tranches have matured: they are assigned thefirst (and potentially all) losses in the investmentportfolio.

Blended Value Investing: Capital Opportunities for Social and Environmental Impact

A bank will initiate a large number of homeloans, lending the bank’s money to homebuyers. The bank can then package the debtinto new bonds, and the coupon and principalpayments associated with these bonds arepassed from the home owners through anintermediary and eventually to the purchasersof the security. Typically, banks will sell thosebonds (and the homeowners’ associated cashflows) to third parties that can manage thevarious cash flows and can distribute or resellthe bonds. Doing so effectively converts abank’s loans receivable into cash immediately,and the bank can then loan that cash to newhome buyers, starting the cycle anew.


2. Investment Due Diligence: The fund mustexamine the likely MFI investments, interviewingmanagement, observing operations, speakingwith clients, and closely scrutinizing financialrecords.

3. Investment Monitoring: After the loans havebeen disbursed, the managers observe theMFIs for any signs of distress or other trouble.Should such difficulties arise, the fundmanagers are likely to provide technicalassistance and counselling, helping the MFI getback on track, or, when necessary, working outof the investments.

The sponsors and fund managers may serve otherroles, depending on the specific situation.

Investment Advisers and Professional ServiceProviders: An investment adviser may bring criticalskills of structuring and placing investmentinstruments. The advisers’ structuring expertisemakes possible the packaging of underlying loansin ways that are most beneficial to both theborrowers and the ultimate investors in thesecurities. Usually, the adviser that structures thesecurity also “places” the final product, actuallyselling the notes to investors. The investmentadvisers typically work with legal and accountingprofessionals to structure and place the securities.

Investors: In the case of the examples reviewedfor this document, investors have included high networth individuals, foundations (investing a portion oftheir corpus in some cases and in others usingprogramme-related investments to qualify theseinvestments as portions of their philanthropicpayout), international development banks, sociallyresponsible investment funds, and others. Someorganizations are working to make investmentproducts available to an increasing number ofsmaller investors. Investors’ motivations andappetites for risk vary widely, making theinvestment advisers’ placement expertiseparticularly important (as the advisers must havekeen insight into the various investors in order topackage and sell the bonds appropriately). Most ofthe investors in these offerings do share an interestin pursuing multiple returns on their capital, returnsthat are both financial and social. Furthersegmenting these investors, understanding theirrisk-reward propensities, and investigating theirother concerns vis-à-vis blended value investingwould be a fruitful subject for future study.

Microfinance Bonds and Securitization:Key Parties

MFIs and Their Clients: At the most fundamentallevel of a debt offering deal is the microfinanceinstitution that makes loans to extremely low-income entrepreneurs. These microborrowers makeinterest and principal payments to the MFI, whichreinvests those cash flows or passes them on toinvestors.

MFI Networks: Numerous but certainly not allMFIs are affiliated with one of many highly reputableMFI networks such as CASHPOR, ACCION andothers. These networks are key components toachieving underlying loan diversification. Personnelin those networks also offer deep expertise in therealm of microfinance: they may be enlisted toperform some of the due diligence and monitoringof the underlying portfolio, and they may also assistin providing oversight, ensuring that the borrowers(in this case the MFIs) maintain their covenants andother commitments associated with thesecuritization deal.

Sponsors and Fund Managers: The securitiesare typically managed by a corporate entity thatdisburses funds to the MFIs, collects the cashflows from the MFIs, and coordinates all of theother actors. The fund managers are responsiblefor screening, due diligence, and monitoring of MFIinvestments (either performing it themselves orcontracting with other organizations to provide it).Fund managers may work closely with partners(MFI networks for example) in dispatching theirresponsibilities, depending on the nature of theirexperience. They manage the administrative andreporting functions associated with note offerings.In the first of several deals, the sponsors havepurchased all or part of the equity tranches.

The fund managers and sponsors perform at leastthree very significant tasks, each of which requiresdeep knowledge of the microfinance sector. 1. Screening MFIs: The fund must determine the

profile of potential MFI investments that will beeligible for the funds. Often the screens includeparameters of the socioeconomic profile ofmicroborrowers and geographic coverage of theMFI. The screens also include financial metricsand thresholds that determine a minimumquality potential investment.



First Case Study: ACCION International’sDomestic Market Bond Offerings 4

The earliest examples of MFI bond issues havetranspired in their own domestic capital markets.Elisabeth Rhyne, Senior Vice-President of ACCIONInternational, reports that in many cases, ACCIONparticularly favours domestic financing deals overinternational transactions (which are described atlength later in this document). She notes thatdomestic transactions offer the following benefits:“Foreign exchange risk is not an issue; sovereignrisk does not limit the bond rating; the magnitudeof the funds raised is appropriate [to local MFIneeds]; local investors are looking for goodplacements." Such MFI bond issues allow thoseinvestors to deploy their capital in ways that alsogenerate local social value. “Moreover,” shecontinues, “there is a contribution to deepeninglocal financial markets when MFIs seek localfinancing.”

Two of ACCION’s affiliates, Mibanco in Peru andCompartamos in Mexico, conducted notabledomestic debt offerings.

Mibanco 5

After financing microentrepreneurs for over adecade as an NGO, Mibanco transformed itself intoa commercial microfinance bank in 1998. By 2001,Mibanco had established links with commercialfinancial institutions that helped finance Mibanco’slending activities through certificates of deposit andlines of credit, which amounted to relativelyexpensive and short-term financing that was undulyconcentrated in a small number of financinginstitutions. Buoyed by an improving capital marketenvironment in 2001, Mibanco’s directors began toexplore financing the bank’s operations through acorporate bond offering. Selling such a security hadthe potential to reduce the cost and concentrationrisks in Mibanco’s existing financing vehicles.

Peruvian securities regulators approved Mibanco'sdemand to issue debt offerings up to 50 millionsoles (approximately US$ 15 million) and agreed toconsider further offerings if the first 50 million solesin debt were successfully placed. In addition todomestic securities experts, Mibanco hiredPeruvian Citigroup affiliates to structure and placethe offering. The investment advisers beganmarketing an initial 20 million sole issue with a two-year maturity and 12% yield. USAID contributed aguarantee of up to 50% of the principle (thus

investors would be protected against losses of upto 50% of their initial investments), which helpedthe issue earn an AA rating by two local creditrating agencies.

Mibanco ultimately offered the bonds through aDutch auction, which was ten percentoversubscribed. Though investor interest (much ofit on behalf of local pension funds) was healthy, thenotes’ yield was relatively high, 690 basis pointsabove the domestic inter-bank lending rate.6 Theissuers posited that the interest rate premiumwould shrink as the capital markets became morecomfortable with the concept of an MFI issuingcorporate paper.

Indeed, their conjecture was confirmed whenMibanco issued a second 20 million sole tranche inSeptember 2003. Structured similarly to the firstissue, the second relied on a 50% guarantee froma regional commercial bank. These 27-monthmaturity notes yielded 5.75%, reflecting a 225basis point drop in its interest premium. (Note thatin the intervening months between the first andsecond issues, the inter-bank lending rate fell from5.1% to 3.5%.) Furthermore, the investor basebecame more diversified, including Peruvian banks,insurance companies and other entities. ACCIONand Mibanco estimate that Mibanco’s net cost forthe second issue totalled 7.01% after factoring inthe costs of the credit guarantee and other bankingand legal fees.

Ultimately, in October 2003, one month after thesecond issue and based on the favourablereception of its previous issues, Mibanco offered athird issue. This 10 million sole issue had no third-party guarantees to enhance the issuer’s credit;nevertheless, it received ratings of AA- and A+ fromlocal credit rating agencies. Again, the notesyielded 5.75%, this time with an 18-month maturity,but this issue was oversubscribed by 70%.Notably, Mibanco’s effective cost including feeswas 6.1%; the lower cost reflected, in part, theobviated need to purchase a credit enhancement.

ACCION reports that the three note issues helpedMibanco match the maturity of its assets andliabilities and reduce its average cost of funds bymore than 50 basis points. At the same time,Mibanco also reduced the average interest rates itcharged its clients by more than 700 basis points,thanks in part to its new access to lower-costfunds.



Financiera Compartamos

Like Mibanco, Financiera Compartamos is anACCION International-affiliated MFI that began asan NGO. Operating in rural and urban Mexico,Compartamos converted to a regulated financialintermediary in 2000. Under Mexican regulations,Compartamos could raise funds through inter-bankborrowing and through the capital markets, thoughit was not permitted to take deposits from thepublic. Between 2000 and 2002, Compartamoshad been capitalized with equity and short-termlines of credit, but by mid-2002 the bank’s 100%annual growth rate had outstripped the capitalsupplied by those sources. The terms on whichCompartamos accessed short-term credit requiredthe institution to maintain a significant reserve thateffectively increased the cost of borrowing andlimited the MFI’s ability to serve its customers.

Compartamos turned to the capital markets toprovide the funds that could support its growth.After obtaining regulatory approval, Compartamoscontracted a local investment bank to structure the100 million peso (approximately US$ 10 million),three-year issue that included no third-party creditenhancements. A Mexican-A1 rating from a localbranch of Standard and Poor's allowedCompartamos to fix the yield at 250 basis pointsabove the Mexican short-term treasury bills at thetime of issuance. Though the yield was 13.1%, itwas still 450 basis points below Compartamos’sprior cost of borrowed funds. A local brokerage(affiliated with Banamex-Citigroup) privately placedthe notes with local institutions and investors.

Given the success of its first offering, later in 2002and then again in 2003 Compartamos offered twomore 50 million peso issues (with a longer maturitybut similar coupons to the first offering). Betweenthe two private offerings, Compartamos was ableto fully finance 35% of its lending portfolios withthese lower cost liabilities.

By 2004, Compartamos’s growth had continued,and it looked again to the capital markets. After thesuccess of the three privately placed issues, theMFI opted to offer securities to the public market.Public offerings are often synonymous with higher-risk, less liquid securities due to fewer investorsand higher placement costs. Offering notes to thepublic would allow Compartamos to reach manymore investors, though many of them would needadditional assurance that indeed this new type of

security bore predictable (and relatively low) riskcharacteristics. Accordingly, Compartamosarranged a partial guarantee on the bond’s principlefrom the International Finance Committee (IFC).

The five-year, 500 million peso offering wasstructured in a series of tranches. The 190 millionpeso senior tranche enjoyed the benefit of a 34%guarantee from the IFC, which, in turn, helpedgarner an AA rating from local Standard and Poor'sand Fitch-affiliated credit rating agencies.

Examples Outside of Latin America: ApproachingSecuritization

In 2004, Indian MFI SHARE Microfin Limited (SML,also an NGO that had converted to a regulatedfinancial institution) and ICICI, one of India’s largestmainstream banks, initiated a transaction whereinthe commercial bank purchased 25% of SML’s loanportfolio for US$ 4.3 million. Through thetransaction, SML was able to borrow funds atapproximately 8.75% (versus the 12-13% that ithad previously paid to access commercialfinancing). The transaction was facilitated by a cashdeposit (made by other partners, including theGrameen Foundation) that functions as a first lossprovision. ICICI later resold the loan portfolio toanother Indian bank.7

Though this transaction did not “productize” theloan portfolio to the extent that the commercialmortgage-backed securities productize theirunderlying securities, it is a notable and rareexample of a secondary market transaction for MFIdebt. The SML transaction also differs from theMibanco and Compartamos note issues in that thedeal packaged and sold existing loans, whereasthe ACCION affiliates sold securities to initiate newloans. All of these transactions depend on thefundamental soundness of microentrepreneurs’ability to be good financial customers who cangenerate financial value with small loans and canassiduously honour their loan commitments. Fromthe perspective of an investor buying the securitiesissued by these MFIs, an investment in theMibanco and Compartamos notes are firstinvestments in the MFIs themselves. They will onlymeet their financial obligations if the MFIs fulfil allaspects of their business—from identifyingcustomers to initiating business to administeringloans—efficiently and competently (and, of course,through it all, the customers must pay their loans).The investors in the SML portfolio purchased loans


that already had established track records, and sothe success of that portfolio would have little to dowith SML’s ongoing lending and other businesspractices (though SML remained the collectingagent for the loan portfolio).

Barriers to Full Securitization

A number of obstacles currently make it difficult forMFIs and their investment advisers to offer truesecuritization deals. These securities requireconsiderable financial engineering and so suchdeals must be of a sufficiently large scale before amainstream bank would devote its structuring andadvisory services to such a deal. Microloans alsorequire relatively expensive and activeadministration, and the MFIs themselves have thegreatest expertise in this realm and in most casescan perform that maintenance at the lowest cost.Accordingly, it would be difficult for an MFI to sell itsloans and then have nothing to do with themwithout third parties to continue administeringthose loans. The SML-ICICI deal overcame thisobstacle by contracting SML to continueadministering the loans even after it had sold themto ICICI. Finally, the maturity of the microloans(often less then one year) can limit the maturity ofany securitized notes.

None of these obstacles should prevent theultimate securitization of microloans, and thosechallenges can be met with the sort of financialengineering that mainstream investment banksdeploy in their regular business. As mainstreaminvestors become more comfortable with theinvestment prospects of microentrepreneurs and asthe cost of administering microloans continues tofall (through adoption of technology and sharing ofbest practices), full microfinance securitization dealswill become reality.

An Introduction to International Debt Offerings

The examples above were confined to thecountries in which the MFIs operate: themicroentrepreneurs, MFIs, banks and investorswere all in the same countries. Structuring suchdeals where the borrowers and lenders operate indifferent currencies magnifies the complications,particularly in that such international lendingintroduces foreign exchange risk, along withregulatory complications. Nevertheless,

Figure 1: BlueOrchard Microfinance Security I Capital StructureTransaction Structure

(Millions US$)

Source: BlueOrchard and Developing World Markets, BOMFS-I Investor Presentation


international financial transactions have thepotential to open a still-larger pool of availablecapital to microfinance and other blended-value-creating systems.

One of the largest and first internationalsecuritization deals was completed by BlueOrchardFinance (BOF), a Swiss microfinance consultancy.In addition to offering BlueOrchard MicrofinanceSecurities (BOMFS), BOF manages the DexiaMicro-Credit Fund and serves as a sub-adviser tothe ResponsAbility Global Microfinance Fund, bothof which work to link capital markets with MFIs.

The first and second closing of the BOMFS-Isecurities in 2004 and 2005 respectively broughtthe total capital raised to US$ 87 million. Structuredand privately placed with the assistance ofboutique investment adviser Developing WorldMarkets (DWM, discussed further below), thesecuritization deal included five tranches, all with amaturity date of 2011. The transaction structure isdetailed in figure 1. Notably, the Overseas PrivateInvestment Corporation (OPIC), an agency of theUS government, guaranteed the senior tranche ofthe offering. The success of BOMFS-I has led bothBOF and DWM to consider future offerings ofsimilar securities.

Writing after the first closing (but before the secondclosing) of BOMFS-I, Meehan reports:


“There were a total of 66 total investors: 12 foundations, 15 MFIpractitioners/investors, 11 socially responsible investment (SRI)managers, 3 SRI funds, 22 private investors, and 3 institutionalinvestors. … Equity investors …include BlueOrchard Finance…Developing World Markets … .[Grameen Foundation USA],Omidyar Network, and Skoll foundation.” 8


Second Case Study: Global Partnerships’International Debt Offering 9

The Global Partnerships Microfinance Fund 2005was not the first international microfinance debtoffering, nor was it the largest or the highest profile,but it is remarkable for a number of other reasons:• First, Global Partnerships (GP) has made an effort

to extend the financial product to MFIs thatwould not likely have had access to commercialcapital;

• Second, the very recent issue facilitated by GPdemonstrates some of the trends toward a moreefficient, broader market for these sorts of deals;

• And finally, the issuers are already consideringanother similar offering, which has thrown thelessons learned into sharp relief as they moveforward.

Introduction to Global Partnerships

Seattle business professional Bill Clapp and his wifePaula founded Global Partnerships as a privatefoundation in 1994 after they saw thetransformative power of microfinance in El Salvador.Their organization set out to support microfinanceinstitutions in Central America, particularly inNicaragua, Honduras, El Salvador and Guatemala.In particular, GP supports “innovative microcreditprogrammes that incorporate components such aseducation or healthcare, or programmes that areworking to solve challenges faced by the growingmicrocredit industry."10 In addition to financialsupport and technical expertise, GP hasinaugurated a policy initiative to make povertyelimination a top American priority.

GP’s programmes cover a range of issues andinitiatives, but all intend to remove the barriers thatprevent poor Central American families fromexercising their inherent entrepreneurial ambitions.Beyond supporting microfinance-relatedprogrammes, GP also advocates for policy changeand international dialogue that will enhance theeconomic and political environment formicrofinance in Central America.

In over a decade of supporting its Central Americanmicrofinance partners, Global Partnerships hasdeveloped a distinct expertise in helping scale andsupport growing MFIs and related programmes.Over the course of this work and in its closerelationships with American donors, the

organization recognized that Central AmericanMFIs' need for additional capital (and theirremarkable ability to deploy it for social andeconomic value creation) exceeded their donors’capacity to provide it. They turned to the capitalmarkets to generate those funds.

International debt offerings are the product of manydifferent partners, each bringing specialized skills.Global Partnerships brought its deep knowledge ofCentral American microfinance and the ability to getcapital in the hands of MFIs very quickly. While theorganization had close connections with donorsand other potential investors, it lacked expertise instructuring investment products. Gary Mulhair,Global Partnerships' managing partner, found thatexpertise in the Developing World Markets (DWM),a boutique investment advisory in Connecticut,USA, and in Orrick, Herrington & Sutcliffe LLP, aninternational law firm.

Developing World Markets

DWM was founded originally as an emergingmarkets investment fund, a line of business thatlater led to investments in initial public offerings indeveloping markets. DWM partners Peter Johnsonand Judy Kirst-Kolkman found their entrée tomicrofinance in 1999, when they invested some ofthe profits from their successful investment fundsinto a revolving loan fund for Pro Mujer, anorganization that establishes and supports LatinAmerican MFIs. What began as a philanthropicventure became a business proposition as DWMincreasingly focused its attention on providingprofessional financial services for MFIs. In the early2000s, the partners began to conceive of a newmission for DWM, one that would deploy theirextensive finance and investment expertise in themicrofinance field.

DWM’s first high-profile deal closed in 2004, whenit replaced a “white-shoe” investment bank instructuring BlueOrchard Finance’s first internationalmicrofinance debt offering. Though theBlueOrchard deal totalled over US$ 87 million(including the first and second closings), Johnsonindicates that such debt offerings are still too smallto appeal to large-scale investment banks.Accordingly, such deals are ideal for boutiqueinvestment advisories like DWM, which nowdevotes the majority of its management attention tothese specialized financial services.




Johnson and his colleagues have learned tocommunicate with fund managers like BlueOrchardor Global Partnerships as well as potential investors.In structuring these securities, they have becomeexperts in creating financial models of cash flowsfrom MFIs and understanding the risks associatedwith those cash flows. DWM has learned the needs,concerns and interests of its potential investors, whoinclude high net worth individuals and their privatewealth managers, foundations, socially responsibleinvestment funds, other institutional investors, andinternational development banks—each with theirown needs, concerns and interests. Johnson andRoger Frank, DWM managing director, suggest that itis not easy to segment these investors whoseappetites for investment risk and reward and thosewhose understanding of the microfinance sector varywidely. The new dimensions of microfinancesecurities and the awakening of the investmentcommunity to them make DWM’s expertise all themore valuable.

Orrick, Herrington & Sutcliffe LLP (Orrick)

As Mulhair planned to launch a securitization deal tomeet the demand he saw in Central America, he alsoturned to international law firm Orrick, which hadprovided legal advice for the BlueOrchardMicrofinance Securities. For Global Partnerships,Orrick was instrumental in structuring the entity thatwould manage the securitization fund. Without carefulplanning, managing an investment fund would makeGP appear to have extremely high overhead on itsfinancial reports. Such a condition would not interferewith GP’s legal and responsible management of thefunds; instead, it would make GP unappealing todonors (the equivalent of dramatically reducing thenet margin percentage of a for-profit corporation). GPcould not afford to hamper its ability to raisedonations, which fund various microfinance projectsthat are not appropriate for commercial financing.Orrick’s solution for GP appears to be a replicablemodel for organizing an American non-profitmicrofinance fund management organization.

In essence, Orrick and GP created a limited liabilitycorporation called Global Partnerships MicrofinanceFund 2005, LLC (GPMF) in which GP is the onlymember. All activity and cash flows associated withthe securitization pass through the LLC. Specificallyhow this corporate structure resolves GP’s financialreporting concerns is beyond the scope of this paper,but it also resolves some investors’ concerns. Mulhair

expressed that indeed it is important to create aninvestment vehicle that is familiar for investors, andthe LLC serves that purpose. Whereas “investing”in a non-profit may be a foreign or confusingconcept for some investors, the LLC is common tomany private investments.

Screening Potential MFI Investments

Mulhair developed a distinct profile for potential MFIinvestees. He focused primarily on MFIs growing at20-40% per year and that would likely continue todo so for several years. All of the funds underconsideration for participation in the offering had todemonstrate that they were profitable on asustainable basis. For funds in this category,growth comes from three sources: • They are making more loans in the communities

where they are operating; • They are making larger loans to established

customers; • They are expanding into new geographic

markets.

The first and particularly the last means of growthrequire the MFI to invest additional resources ininitiating those new loans.

In order to be eligible for GPMF’s consideration, theMFIs had to be sufficiently well run and have thesystems in place to scale with their growth inlending. Finally (and related directly to the lastpoint), Mulhair only considered MFIs that had atrack record of rapidly deploying their capital. Hedid not want his investors’ money sitting idle; hewanted it working immediately for poorentrepreneurs.

This profile is remarkable in that it does not targetthe lowest-risk, first-tier MFIs (which have betteraccess to capital than do the institutions GPMFtargeted). The profile likely increases risk to someextent, as growth can hide problems. Nevertheless,the exhaustive due diligence process, the loanagreements’ covenants, and the post-investmentmonitoring allow GPMF to understand and managethe risk. Mulhair reports:

“These MFI’s are the most rapidly growing providers of capital to thepoor, and they are doing it with sustainable business models. Theyare the future leaders of the microfinance industry.”


Structuring the Investment

Mulhair was highly engaged in creating a structurefor the GPMF investment that would satisfy boththe MFIs and the investors. Beginning in autumn2004, he first went to potential MFI investees todiscover what borrowing and repayment structuresmade the most sense for them. Eventually, Mulhairtailored the fund to their particular needs as best hecould.

First, Mulhair discovered that the MFIs were hungryfor capital. Many estimated that they had onlypenetrated five to ten percent of their potentialmarkets, and the most established groupsindicated that they had only reached 20% of theirpotential borrowers. He inquired into MFIs’alternative sources of capital and discovered thatthe target MFIs could afford—and would bewilling—to pay eight to twelve percent interest onfunds borrowed from GPMF. The MFIs alsoexpressed a desire for long-term loans that wouldnot require frequent renegotiation. MFIs growing atrates of 20 to 30% per year found that shorter termloans imposed a painful fundraising burden: notonly were the MFIs raising debt to fund expansion,they had to raise funds to replace maturing debt.Finally, the MFIs expressed that they wanted theirinvestors to become long-term partners with whomthey could establish trust and track records thatmight be leveraged in future rounds of financing.Accordingly, GPMF anticipates that futurefunds will make additional investments in theMFIs that received earlier loans.

After discovering what the MFIs needed,Mulhair approached potential investorssuggested by DWM. He first identified theircommon concerns, which included the levelof investment concentration in single countryor MFI, the duration of the notes, and thelevels of debt subordination available.Understanding those general concerns,Mulhair hosted a series of focus groups withpotential investors, testing various structuresuntil he arrived at the fund’s ultimatestructure. His research paid off in making theissue fairly easy to place. Mulhair indicatedthat it took only 45 days to place the entireoffering, which closed in September 2005. Inoffering the securities, GPMF discovered agreater-than-expected demand for the higher-yield subordinated notes as well as that themarket might bear senior notes with a lower riskpremium—an important insight for possible futureofferings.

Unlike the BlueOrchard securitization, GPMF’sinvestment structure did not include theparticipation of any government entities to lend theissue their credibility. Thanks in part to otherpioneering securitization deals like BlueOrchard’s,many potential investors had become sufficientlycomfortable with the investment structure that theywere willing to invest without having co-investing orcredit-enhancing agencies to signal the offering’ssafety. In early 2006, at least one other group waspreparing a securitization deal that will considerablyexceed GPMF in size and will do so with minimalcredit enhancements.11

Mulhair and GPMF deliberately kept this first fundat a relatively manageable US$ 2,000,000. All ofthe notes had a five-year maturity and a fixed yieldbased on the four-year US Treasuries rate at thetime of issuance. 80% of the offering’s value, US$1,600,000, was senior notes with a yield premiumof 1.5% over the applicable US Treasuries. Tenpercent of the offering, US$ 200,000, wassubordinated notes with a yield premium of 2.5%over the US Treasuries. The remaining ten percentof the offering was the equity tranche. GP (the non-profit, not the fund management entity) contributedthe entire equity tranche, and in the process agreedto accept first losses up to US$ 200,000. (Seefigure 2 for a graphical representation of the fund’sstructure.)


Figure 2: Global Partnerships Microfinance Fund 2005 Capital StructureFund Capitalization

Source: Global Partnerships and Developing World Markets,Global Partnerships Microfinance Fund, 2005 Investor Presentation

* Not shown: cash build-up during life transaction


Though the fund’s offering memorandum stipulatedthat GPMF could take up to six months to disbursethe funds to MFIs, Mulhair reports that the fundswere disbursed within 60 days, thanks to GP’sfluent knowledge of potential MFI investees gainedin part through a due diligence process that beganbefore GP even closed the fund. Though it is tooearly for GPMF to have a proven track record,Mulhair sees enough demand from both MFIs andpotential investors that he is already working onstructuring GP’s next fund. That fund, he says, willbe larger, and he aims to have it entirely disbursedto MFIs within a month of his collecting it frominvestors. Mulhair and DWM have returned to theirpotential investors for input on the next fund’sstructure. He anticipates raising that fund in the firsthalf of 2006 and then raising a series of other largerfunds over the following five years.



Goal: Efficient Capital Markets

Mulhair (along with many others) looks forward tothe day when MFIs have access to a wider varietyof capital sources funded by myriad investmentproducts. Those MFIs will be able to chooseamong many sources of capital, including sellingequity, borrowing on various terms, deploying theirown retained earnings, and mobilizing their clients’savings. More diverse financing sources offeringcapital on different terms will allow MFIs tostructure the capitalization that best suits theirneeds and the needs of their clients (just asbusinesses in the developed world have greatflexibility to structure their own capitalization to thebenefit of customers and shareholders). The worldhe describes is also known as an efficient capitalmarket, and it certainly does not exist yet.

Many professionals in the field look forward to thetime when mainstream financial investors recognizemicrofinance investments as legitimate and usefulasset classes with measurable and attractive risk-reward characteristics, asset classes that can addvaluable dimensions to a portfolio of investments.They envision a range of reasonably standardinvestment products that can be dynamically pricedand traded in secondary markets. Looking at thefundamentals of the securities that they arestructuring, DWM and other professionals believethat microfinance securities will eventually be ableto stand on their own, appealing to investorswithout needing a “socially responsible crutch”, andwithout any concession to the risk-adjusted marketrate of return. Many feel that these products will bevery desirable because they are both safe andrelatively uncorrelated to other asset classes.

Obstacles to Efficient Microfinance CapitalMarket

Raising Capital: Obstacles Facing theMicrofinance Capital Supply

Currently, many potential investors remain ignorantof the existence of microfinance investmentproducts, and many potential investors areunfamiliar with the existing underlying microfinanceindustry. Potential investors may not understandthe risk profile of these products, nor may theyunderstand the potential benefits (financial andsocial) of investing in them. All these factors worktogether to create obstacles to expanding investingin this arena.

Those investors who have expressed interest inthese products are very fragmented in theirinvestment needs and interests. A high net worthindividual who has previously donated funds toMFIs and wants to advance the state of the art ofmicrofinance would have fundamentally differentmotivations and expectations than would a pensionfund manager interested in a fixed income securitythat will be relatively insulated from Americanmacroeconomic cycles. Roger Frank of DWMsimplifies the variety of investors’ interests bydrawing a three dimensional grid, which heacknowledges does not have enough dimensionsto plot a single investor’s profile. On the x-axis hedraws a risk-reward continuum; on the y-axis heplots geographic exposure; on the z-axis is aninvestor’s interest in social returns. Every investor’spoint in that three-dimensional space is different,and so each investor’s demand for investmentproducts is also relatively unique. If Frank were toplot all of their potential investors in that three-dimensional space, there would be points all overthe space. Accordingly, each new potential investorneeds to be looked at individually.

Because they are a relatively new investment class,microfinance notes currently lack well-establisheddata on their performance as securities. Portfoliomanagers whose investment decisions are data-driven simply do not have access to historicalreturn and volatility measurements for theseinvestment products, and so they will avoid themaltogether. Academics will find it challenging togather enough data to analyze how these securitiesare correlated with other investments, though manybelieve that the securities will prove to be largelyuncorrelated. The obstacles continue: mainstreamcredit ratings are rarely available for thesesecurities, and with so few of these securitieshaving been issued, a viable secondary marketdoes not yet exist.

Those obstacles notwithstanding, the fundamentalsof the underlying loans to poor microentrepreneursappear remarkably firm. Frank claims: “I cansoundly win any arguments about the fundamentalsof the underlying assets, but I simply cannotcounter arguments about liquidity of the notes orabout the lack of ratings standards. Solidfundamentals are the best insurance policy.” Givenhis finance background and proximity to theseinvestments, the notes’ quality is evident to him.Fortunately, strong fundamentals portend bothtransparent ratings standards and, ultimately, apotentially vital secondary market.

Emerging Issues in MicrofinanceSecuritization


Concerns about Microfinance-Backed Securities

Some microfinance experts raise concerns that theabundance of debt capital available to MFIs coulddistract them from mobilizing their borrowers’savings as a source of capital. If an MFI can acceptdeposits, it can access those funds to makeadditional loans. Unfortunately, it takes considerableeffort and cost to offer these products, and in manyparts of the world an MFI must be regulated by thestate before it can accept deposits. Theserequirements preclude many of the not-for-profitand informally organized MFIs from developing thissource of capital. (It should be noted that suchMFIs are also at a disadvantage in seekingcommercially available debt financing.) Savingsaccumulate gradually, so that source of capital maynot be immediately available to finance growth.While an MFI may be consumed with securing debtcapital and be distracted from establishing savingsprogrammes for poor clients, there is ampleevidence that strategically minded MFI managersare planning on capturing future savings once theyare regulated and are using debt as an interimsource of capital.

Many microfinance experts also raise concernsabout US dollar-denominated loans to MFIs. Wheninvestors loan in dollars, they also expectrepayment in dollars, while the MFIs must makemicroloans in local currency. This arrangementexposes the MFIs to currency fluctuations (becausethey must undertake the conversion from hard tosoft currency). While such variation canoccasionally work in the MFIs’ favour, many fearthat such fluctuations—especially those caused bydrastic local currency devaluations—will work to theMFIs’ detriment. US dollar-denominated loans tendto be appealing because they carry a nominallylower interest rate. On the other hand, loansdenominated in local currencies usually place theforeign exchange exposure on parties other thanthe MFIs (and their clients); nevertheless, theseloans tend to carry higher interest rates. Within theMFI establishment there is a vigorous debate aboutwhether hard-currency or soft-currency loans arepreferable. Engaging this debate’s nuances remainsbeyond the scope of this study, though thisdocument includes additional discussions of foreignexchange risk management. Ultimately, MFIs needaccess to all manners of capital, including hard andsoft currency loans. The MFIs themselves shouldbe able to choose the financing instruments andcapital structures (that may blend hard and softcurrency loans) as the MFIs themselves deemappropriate.12

Other critics suggest that widely availablecommercial financing could encourage MFIs tomove up-market, making larger loans to less-poorpeople. Such loans tend to be less costly toadminister and are perceived to be lower risk(though many would argue that they are not). AnMFI that moves up-market could run the risk itselfof changing the fundamental underlying assetssuch that the non-correlation benefits are eroded—not to mention that moving up-market couldinclude abandoning the poorest customers whoneed microcredit the most.

Similarly, some microfinance professionals expressconcern that emphasis on directing investment-grade capital to MFIs could staunch the flow ofdonated capital into the microfinance sector.Microfinance was built on grants, which still makeup the majority of the capital that is ultimately lentto poor entrepreneurs; choking the flow of donatedcapital would have a disastrous effect on MFIs andtheir clients. Even if the volume if investment capital(in the form of debt and equity) rises dramatically tomeet the expansion needs of established MFIs,grant capital will still play important roles infounding new MFIs, funding innovation and helpingmanage market inefficiencies that may persist incertain geographies or business models. (Forexample, one can imagine an isolated, smallcommunity that could benefit from microfinance butlacks infrastructure, scale and proximity toestablished financial institutions. Grant funds willlikely always be necessary to bring microfinance tosuch communities and to establish whethermicrolending can be conducted sustainably therein.If for any reason the practice is not sustainable,grantors may choose to continue funding thismicrofinance initiative to create social value even ifit cannot return financial value to the financialbackers.) Microfinance generates value in multipledimensions, but different microfinancearrangements can generate very different blends ofthose returns. In some cases, microloans generatesignificant social value but cannot generate returnsfor investors—even when the programmes areadministered efficiently.13 Such programmes shouldbe funded by donated capital (or through someother form of financially risk-tolerant investment) byinvestors who value that particular blend of socialor economic returns.

As this capital market is new and emerging, thereare also concerns that the risk associated with theproducts has not been appropriately priced.Wrongly priced risk can amount to a hiddensubsidy or quota that could distort the market,

Emerging Issues in MicrofinanceSecuritization


Emerging Issues in Microfinance Securitization

resulting in either too much or not enough capitalflowing into these investments. Some fearmicrofinance securitization could become a victimof its own success. If too much capital flows toMFIs, lending practices may become sloppy,resulting eventually in unforeseen defaults. (SeeNurcha in the following section for an example ofthis phenomenon.) If the risk of any giveninvestment remains wrongly priced, perhapsthrough the subsidies provided by sociallyconscious investors willing to accept concessionaryfinancial returns, over the long run not enoughcapital will flow to the sector and worthy MFIinvestments will go unfunded.

Signs that the Market Is Becoming More Efficient

The nominally low cost of capital associated withmobilizing clients’ savings may well serve as asufficiently strong motivation for MFIs to makeadditional savings and deposit facilities available totheir clients (provided that organizational structureand regulatory environments permit this).Furthermore, such products engender socialbenefits by making the MFIs’ clients morefinancially sustainable, which amounts to strongmotivation.

As these products become more widely available,the market will become more proficient at pricingthe risk associated with each deal. Experts arelearning how to price these securities, and what isnow something of an art will over time become ascience as investment advisers and fund managersoffer more microfinance securities. Likewise, theseexperts are developing more sophisticated andincreasingly appropriate structures, as can be seenin GP’s plans for future offerings with new equityand subordinated tranche features. As moreinvestment banks grapple with structuring andpricing issues, there will need to be an efficient andtransparent forum for communicating pricing andstructure information, which will be essential toprice risk.

While international debt offerings are not yetapplicable to the majority of MFIs, this conditionshows signs of changing. While the BlueOrchardsecuritization worked primarily with top-tier, high-performing MFIs, Global Partnerships hasdemonstrated that the product is moving downmarket, funding MFIs that are still maturing.Johnson of DWM is confident that the trend cancontinue, as mainstream investment bankers haveample experience securitizing higher-risk loans likecredit card receivables and potentially risky autoloans.

The number and variety of products in the planningor placement phase seem to be increasing daily.Many of these products have not been madepublic, but there are a number of innovative,intelligent and socially motivated professionalsdevoting their time and energy to giving MFIsaccess to mainstream capital markets. At thecurrent rate of creativity, a report of this naturemight be issued semi-annually, each time featuringa new path-breaking approach to linking poormicrofinance customers to mainstream financialcapital markets.

Looking to the Future

The number and variety of securitization dealsseems likely to increase exponentially in the nextseveral years. The causes of this growth are many,but underlying all of them are two strongfundamental conditions: microfinance works, andthere is very powerful demand at the bottom of thepyramid. With millions of impoverished potentialmicroentrepreneurs and an ever-increasing numberof MFIs arising to meet their financing needs, therewill be unmet demand for capital into theforeseeable future. That demand will drive financialinnovation and forge connections between those inthe developed world who control capital and thosein the developing world who only need a small bitof it to improve their lives profoundly.

Microfinance has the potential to bring millions ofpeople out of deep poverty. To do so, the industryneeds a new group of financiers capable ofincreasing the amount and various forms of capitalavailable in this market by an order of magnitude—and to do so without stemming the flow of donatedcapital to MFIs where such capital is the mostappropriate fuel for their development.

While the power of microfinance to expandeconomic opportunity for very low-incomeindividuals is key, microfinance also holds thepotential for achieving something more. Indemonstrating its effectiveness, the organizationsprofiled in this and other documents aredemonstrating how to achieve financialperformance together with significant social impact.

Microfinance professionals are not the onlyinnovators in debt financing. In the United States,several decades of community developmentinvesting have driven financial innovation as well.The following case study examines how communitydevelopment investors in the US have contributedtheir innovations to a unique programme fosteringthe development of free democratic societies.

Third Case Study: Community Investing,Media Development Loan Fund, and CalvertSocial Investment Foundation14

Media Development Loan Fund

Media Development Loan Fund (MDLF) invests inindependent news media outlets in emergingdemocracies, offering what Deputy ManagingDirector Harlan Mandel calls “direct economicinvestment in democratic change.” MDLF’sinvestors, managers and investees share thefundamental belief that independent media areessential to the development of productivedemocratic societies. In countries establishing theinstitutions of a participatory government and theopen expression of a free society, independentmedia can begin to right the wrongs of oppressiveregimes, giving voice to ethnic, political, or socio-economic groups that had previously beensilenced.

Independent media and news outlets in emergingdemocracies often face a host of market and non-market obstacles to sustainability—and sometimesto their very survival. Licensing requirements andother regulatory restrictions can impede the freepublication and broadcast of independent ideasand views. When those media organizations arefree to operate, they often face competition unfairlysubsidized by political and economic elite.Furthermore, financing vehicles are oftenunavailable to companies facing those sorts ofrisks, and capital that is obtainable may impinge onan outlet’s editorial independence.

Founded as an American not-for-profit corporationin 1995, The Media Development Loan Fundprovides below-market rate financing with technicaland managerial assistance to the fledgling mediaoutlets crucial to many countries’ transformation tofree democratic societies. MDLF primarily offersconcessionary rate loans and lease financingarrangements to newspapers, publishers, televisionand radio stations, and digital media outlets. It alsotailors the financing arrangements to the needs ofits clients, and it will even initiate equity financingunder certain circumstances. With headquarters inNew York City, an operations centre in Prague, andoffices across the world, MDLF manages a pool ofcapital provided by donors and by programme-related investment (PRI) lenders.

The organization adds the engagement of a venturecapital investment—often taking a board seat,offering strategic consulting, and monitoringoperations closely—to its debt financing. Mandelexplains that debt financing encourages clients,which are locally owned small businesses, to planfor sustainability and to aim for reliable cash flowsthat will cover the interest and principal payments.That discipline forces the client to respond to theiraudiences and to sell products. MDLF observesthat the obligation to make regular payments forcesclients to write business plans and then to adhereto them—a valuable outcome that standard grantswould not necessarily confer.

MDLF tends to avoid financing working capital,instead aiming to finance assets that will helpclients achieve financial independence. Commonly,clients purchase a key piece of productionequipment like a printing press, audio-visualproduction equipment or information technology


A Note on other Debt Financing Innovations

“While independent news organizations arecommercial enterprises, at the heart of MDLF’swork is the notion that the best are much morethan that: they are social enterprises, committedto truthful and ethical journalism, and theirdevelopment is a prerequisite for any functioningdemocracy. They provide information needed forcitizen participation in the democratic processand for the functioning of market economies.They play an essential role in economicdevelopment, and in extending the benefits ofdevelopment to those in poverty. As MDLFdescribes it, they give a voice to the otherwiseunheard and open the government and theeconomic affairs of a nation to public scrutinyand debate. They expose corruption and shine alight on issues critical to countries in transition:health, economic development, treatment ofminorities and the environment.”

Source: Calvert Foundation Case Study of MDLF.Unpublished. October 2004.


infrastructure. A printing press, for example, notonly frees a newspaper from depending on state-controlled printers, it can improve a newspaper’squality such that it wins new advertisement income,allowing it to produce a less expensive and moreattractive product. Many clients will be able to sellexcess capacity on the new presses, bringingadditional income.

MDLF’s Investment Process

MDLF’s deal flow varies by region. In the Balkans,Russia, Ukraine and elsewhere, MDLF hasestablished a reputation that brings unsolicitedpotential investments to the fund. In otherlocations, especially as the fund expands into newgeographies, MDLF depends on other media-support organizations or its own prospecting foreligible independent media investments.

Fund staff screen potential investments for both thesophistication that engenders sustainability and theindependence that advances democratic progress.The organization’s directors have established thefollowing guidelines for potential investments.15

Once a potential investment meets these criteria,having passed through a screen for social value,MDLF pursues financial due diligence. MDLF’s staffwill only recommend investments that affirmativelycreate social value and that appear well positionedfinancially. An independent investment committeemakes the ultimate investment decision.

MDLF’s Investment Portfolio

By late 2005, that process led to about US$ 45million in investments to nearly 50 differentcompanies. With approximately US$ 15 millionreturned through principal payments (and then re-lent), the organization was managing a loanportfolio of about US$ 30 million financing about 30different media outlets. MDLF has made loansranging in size from US$ 100,000 to US$ 7 millionwith a typical range from US$ 500,000 to US$ 1million, and it has initiated an average of 12 to 15loans per year.

The loans and leases, all dollar or euro-denominated, carry interest rates between 5.5 and7.5% and as high as ten percent (though the fundsearliest loans were in the 1-3% range), and theytypically have five- to seven-year maturities. About80% of the loans have been committed to mediaoutlets in the former Soviet Union and the formerYugoslavia, but the fund is expanding in Africa, Asiaand Latin America. MDLF maintains a loss reserveequal to approximately 18% of the total loanportfolio. Close monitoring and involvement haveled to write-offs amounting to approximately twopercent of total invested, low delinquency rates andsignificant recoveries of delinquent payments.

Historically, MDLF’s work has been financed byfoundation grants, individual donations, andapproximately US$ 10 million in PRI debt from theOpen Society Institute, the MacArthur Foundation,the Swedish government and other Europeanfoundations. Recently, the fund has made debtfinancing vehicles much more widely availablethrough its Free Press Investment Notes.Structured by the Calvert Social InvestmentFoundation, which is itself an MDLF investor, thesenotes make blended value investments available toindividual investors, institutions and foundationsinterested in a relatively simple way to supportindependent media and earn a financial return inthe process.


To be considered by MDLF for debt, lease finance orequity investment, a media organization must fit thefollowing profile:1. It must be legally registered according to all

applicable laws. It must have licenses required bylocal laws for media of its kind and, if the applicant isan electronic media, it must have a valid frequencylicense.

2. It must have been in operation for at least a year. TheBoard of Directors may, in extraordinarycircumstances, waive this requirement.

3. It must have a record of promoting democraticinstitutions and practices in its country and must benationally or internationally known for promoting andexercising principles of free, independent andresponsible press.

4. A significant part of the applicant's programme mustbe news, current events, photojournalism, photo-imaging and documentary programmes driven byeditorial staff to exercise fact-based, honest,unbiased, fair, non-partisan, investigative andresponsible journalism, independent from theinfluence of the government or of any other interestgroup.

5. News, current events and documentary programmesmust have a proven record of offering coverage ofdifferent political opinions, promoting human rightsand the rights of ethnic minorities, and promotinginter-ethnic coexistence.


Calvert Social Investment Foundation

One of the first socially responsible mutual fundmanagers, Calvert Group offers individual investorsa variety of screened socially responsible portfoliosof public equities, bonds and other money marketproducts. In the late 1980s the company began toexplore investment strategies that not onlyscreened out social value destruction but soughtactively to create social value with its investments.This discussion eventually led the fund to committo investing one percent of its assets in communitydevelopment finance intermediaries.

To facilitate this style of investing, Calvert Groupeventually founded the Calvert Social InvestmentFoundation (Calvert Foundation) in 1995 with thesupport of national foundations including Ford,MacArthur and Mott. The Calvert Foundation aimsto affect community investment in the same waythat Calvert Group built SRI: the foundation aims torefine the practice and productize investments sothat individual investors can actively participate incommunity investing. In essence, the foundationhas been charged with creating investmentproducts that generate blended value. Overseeingthis mission is Shari Berenbach, the president ofCalvert Social Investment Foundation.

The Calvert Community Investment Note

Calvert Foundation’s flagship investment product iscalled the Calvert Community Investment Note.Structured as general recourse obligation of thefoundation, the notes are designed to make it safeand convenient for average investors to directcapital to community development and otherblended value-generating projects and enterprises.The Notes are highly customizable and can bepurchased in increments of US$ 1,000 (with a US$1,000 minimum investment). Investors can choosethe profile of the investments underlying their notes,targeting specific geographic regions andprogrammatic areas. Investors can also select thematurity of their Notes (ranging from one to tenyears) and the interest rate (from zero to threepercent). Calvert Foundation will build completelycustomized community investment portfolios forinvestors deploying over US$ 50,000 in capital.

In the ten years since the Notes’ inception, CalvertFoundation has nearly US$ 100 million inCommunity Investment Notes outstanding. Thiscapital has been deployed across a US$ 84 millionportfolio of 195 borrowers, including Americancommunity development financial intermediaries,affordable housing developers, microfinanceinstitutions, fair trade cooperatives and otherdomestic and international social enterprises.


Investment case study An example of a successful portfolio company is Altapress in Russia:

Altapress is a newspaper publisher in Barnaul, a city in Siberia close to the Kazakhstan border.

In 1990 five journalists left Barnaul’s communist paper to set up Altapress, the first independent news outlet in the heavilyCommunist region of Altaiskii Krai, southern Siberia. Beginning with the award-winning, general-interest Svobodnyi Kurs (FreeCourse), circulation 35,000, the company today is the 5th largest regional publisher in Russia, with 350 full-time employees andsix newspapers, including a successful weekly business publication. It has a powerful printing business: its two printing presses,both bought with MDLF financing, are the only high-quality, non-state newspaper printing facilities in the area. Its distributionsystem manages some 250 sales stands around the town and region. A modern new building, built partly with an MDLF loan,hosts most of the company’s employees, as well as its training centre, which trains over 400 local students every month injournalism, business, advertising, management and PR. In 2003, Altapress won the Die Zeit Young Press Eastern EuropeAward. In 2001, Altapress General Director Yuri Purgin was selected as Best Media Manager by the Russian Union ofJournalists.

MDLF began working with Altapress in 1999, providing lease financing for purchase of a web offset press for printingnewspapers and a loan for construction of company premises for a printing house and all its other operations. In 2002, MDLFprovided a second finance lease for the purchase of a sheet-fed press for commercial printing. Altapress has been a problem-free borrower and has served as a training ground for all subsequent MDLF newspaper clients in the former Soviet Union. Inrecent years it has gained wide recognition as the best managed regional newspaper company in Russia.

In 2004, Altapress gained international recognition for its public protest against government pressure to publish false articlesslandering an opposition politician. In a rare act of courage and integrity in today’s Russia, Altapress published an open lettersigned by all its journalists, and many others from the region, detailing the government’s pressure and refusing to accede to it.Time Magazine cited the event as a first sign of the potential for democratic change in Russia.15

Source: Shari Berenbach and Harlan Mandel


The underlying portfolios are very carefullyscreened, monitored, and managed. CalvertFoundation has put in place significant securityenhancements that lower the notes’ risk such thatthe foundation has never defaulted on itsobligations to any Community Investment Note-holders. The notes currently have a three percentloss reserve, and they are further collateralized byCalvert Foundation’s balance sheet, which holdssubstantial assets that are junior to the CommunityInvestment Notes. With the portfolios’ average loansize at approximately US$ 400,000, five averagesize loans would have to be complete losses toexhaust the loss reserves, and then realized losseswould have to be substantially larger before theyexhausted the cushion provided by thesubordinated assets on Calvert Foundation’sbalance sheet. By late 2005, Calvert Foundationhad over 2,400 Community Investment Note-holders. The largest note-holders are the CalvertFunds. 2,200 of those investors have invested lessthan US$ 50,000, and 1,000 have invested US$5,000 or less. Many of the 200 investors who haveinvested more than US$ 50,000 are familyfoundations and high net worth individuals.

Building the Community Investment Field

Calvert Foundation has helped to build thecommunity investment market place by teaming upwith partners to support their access to investors’capital. The first strategy used by the foundationhas been to “private label” the CommunityInvestment Note, thereby allowing organizations towrap the investment instrument in their own brand,effectively piggybacking on existing noteregistration and administration. Private label notesdirect capital to specific loan portfolios or borrowingsectors. These notes stay on Calvert Foundation’sbalance sheet like all of its Community InvestmentNotes, and the private label products have thebasically the same structure as Calvert’s own noteproduct. Calvert prepares the prospectuses,manages the registration tasks, handles investoradministration, and collaborates with its partners toreach new investors and investees.



Calvert Foundation limits the aggregate size ofeach these private label arrangements because itsrisk management regime precludes it from investingmore than five percent of its portfolio into any oneorganization. Furthermore, the foundation works tomeet internally defined capital adequacy guidelinesin proportion to the liabilities created by the notes.These restrictions cap the amount of capital thatcan be invested in these customized products.

Establishing the Free Press Investment Notes

Calvert Foundation and MDLF had consideredstructuring the Free Press Notes within the PrivateLabel programme, but MDLF wanted to offer itsown notes with an open-ended size. Accordingly,Calvert Foundation has supported MDLF throughits Community Investment Partners programme.The Community Investment Partners programmemakes Calvert Foundation’s securities expertiseavailable to other non-profits. For MDLF, CalvertFoundation prepared an “independent offering,”performing the role of an investment adviser instructuring a security that is similar to a CommunityInvestment Note offering that would affect MDLF’sbalance sheet, not that of Calvert Foundation. Thetwo organizations launched the Free Press Notes inDecember 2005.

Following MDLF’s Free Press Notes, Berenbachreports strong demand for other similar independentofferings, with several projects in the pipeline. Withmany products that have a standardized structure(the foundation’s own Community Investment Notes,MDLF’s Free Press Notes and the variety of privatelabel notes), the foundation and its partners arefostering a uniform set of expectations for thismanner of community investment product.

“Dematerializing” the Community InvestmentNotes

In its quest to make the notes more ubiquitous andaccessible to more investors, Calvert Foundation isactively establishing partnerships with financialinstitutions and securities brokerages. To make theserelationships possible, the foundation has had torender the notes compatible with the financialindustry-standard electronic transaction systems—asignificant challenge that reveals a subtle butimportant obstacle that many blended valueinvestment products will likely face as they becomemore accessible and productized.

Many financial firms transfer and clear investmentsthrough the Depository Trust Company (DTC), whichmaintains the electronic system through which mostAmerican securities transactions are processed.DTC’s website explains: “The depository bringsefficiency to the securities industry by retainingcustody of some 2 million securities issues, effectively‘dematerializing’ most of them so that they exist onlyas electronic files rather than as countless pieces ofpaper."17 DTC makes securities easily accessible to


Investment notes established through Calvert Foundation’s Private Label programme

Gulf Coast Recovery Initiative Directs community investments to help those who were hardest hit by HurricaneKatrina and other recent devastating hurricanes.

Jubilee Investing Initiative Directs faith-based community investments to non-profit lenders worldwide.

LGBT Community Investment Notes Supports lenders that provide important community facilities and services for thelesbian/gay/bi-sexual/transgender community

National Peace Corps AssociationMicroenterprise Program

Invests in microcredit organizations, primarily FINCA, to offer working capital andfinancial services for the economically active poor around the world.

Oikocredit World Partnership programme Oikocredit was founded 25 years ago as an alternative investment instrument forchurches to provide credit for poor and disadvantaged people around the world.

Grameen Investments Has directed capital to Grameen Foundation USA to help working poor inBangladesh develop sustainable businesses.

MicroVest mPower Investment Program Allows investment in microfinance institutions through the purchase of CommunityInvestment Notes.

Source: http://www.calvertfoundation.org


mainstream financial institutions that maintain theirclients’ portfolios in electronic format. Withoutbeing a part of the DTC system, CalvertFoundation’s Community Investment Notes werenot easily accessible through most investors’securities brokers. Compatibility with DTC wouldlikely enlarge the market for the CommunityInvestment Note products, and it could enlist a newsales channel when retail brokers are able toprovide the product as an integrated portion of theirclients’ investment portfolios.

Unfortunately, gaining access to the DTC was nosmall task for Calvert Foundation, and Berenbachreports that it took nearly seven years toaccomplish it. A key reason for the delay pointsdirectly at subtle but important differences betweentraditional retail investment (strictly for financialreturns) and philanthropic investment (strictly forsocial or environmental returns). Efficienttransactions of most liquid financial products areaccomplished so that buyers and sellers remainanonymous to one another. The products must becompletely fungible, and DTC’s “dematerializing”promotes those characteristics.

That level of interchangeability and anonymitystands in contrast to the norms of philanthropy,wherein donors often customize their investmentsand remain in close contact with recipients(philanthropic donors often want anything butanonymity). The Community Investment Notesbring some of the practices of philanthropy to bearon blended value investing, giving investorsextensive capacity to customize their investmentproducts.

Because the DTC system has been built specificallyto exchange fungible retail investment products, itwas very difficult to make the CommunityInvestment Notes, with their highly variablecharacteristics, interface with the DTC system.Fortunately, in late 2005 Calvert and DTCestablished procedures for clearing the CommunityInvestment Notes electronically. Clearing throughDTC allows Calvert Foundation to establishrelationships with new securities brokers, whichBerenbach predicts will triple the size of its portfolioover the next five years.

The Future of Calvert’s Community InvestmentNotes

Currently, Calvert Foundation’s CommunityInvestments include a large range of underlyinginvestment strategies including affordable housingfinance, microfinance, community facility funds,small-business loans, fair trade investments andinvestments in social enterprises. Looking to thefuture, Berenbach anticipates that in the nextseveral years the foundation will be investing inenvironmental projects, the health sector and off-grid power and telecommunications.



Introduction

At an increasingly rapid rate, blended value projectsare becoming blended value investments that allownew capital to generate blended returns withreduced transaction costs and increasedtransparency. Thoughtful people often do not agreeon exactly how to measure and then price the riskassociated with the new investments. Many suchinvestments look foreign or downright speculativeto investors who oversee mainstream capital. Inmany cases, other actors will view that riskdifferently and will be more willing to expose theircapital to that risk if doing so will encourage otherinvestors. In some cases, the risk-tolerant investorshave unusual insight into the potential investment’sfundamentals. Other risk-tolerant investors mayhave philanthropic motivations for taking on the riskin that they view a loss of capital on such aninvestment the same way they would a grantinvested in developing new socially beneficialinvestment products. A number of actors haveexplored how to share the risks — both real andperceived — between different parties through theuse of loan guarantees and related strategies forstructuring credit enhancements.

A Loan Guarantees Primer

In a standard loan agreement, the borrowerprovides some manner of collateral, giving thelender a claim on the borrower if he or she cannotmeet the obligations of the loan. In collateralizedloans, the borrower’s assets are pledged to satisfythe lender in the event that the borrower cannotmeet the obligation. (In a microcredit context, thecollateral may not be property or assets but “socialcollateral”, or the future loans of others in a lendinggroup.) In a situation where a borrower may nothave sufficient collateral, another party may pledgeassets or its general credit to meet the loanobligation if the borrower defaults. The partypledging the assets is the guarantor, and often itmust place securities or other assets in an accountthat can be easily accessed by the lender in theevent of a collateral call. This is called a loanguarantee or credit enhancement.

In some situations, an entity perceived to carry a lotof risk (such as an MFI or a young company) canreduce its cost of borrowing by having an entitywith a lower risk rating (such as a foundation orinvestor) guarantee all or part of the loan. That

added safety should then lower the cost ofborrowing, though the entity directly benefiting fromthe loan guarantee often must pay a fee to facilitatethe arrangement. Beyond lower-cost borrowing, aloan guarantee encourages follow-on financingboth by removing some of the borrower’s risk andby signalling the borrower’s quality.

Guarantee arrangements vary dramatically. Manygovernment-backed programmes, for example, areguaranteed by the full-faith and credit of thecountry’s government, in which case the guarantordoes not specify any assets to serve as collateral,though a borrower can still make a general claimagainst the guarantors. Most guaranteearrangements require that specific assets bepledged. Often pledged financial assets aresegregated from a guarantor’s other assets in aspecial bank or brokerage account, and real assetswill be subject to some form of contractdetermined by the guarantee agreement.

If the guarantor pledges financial assets, theguarantee agreement may limit the kinds ofinvestments that are eligible for investment, but theguarantor receives the benefits of any capitalappreciation (or the exposure to any losses)generated by the investments. Accordingly, manyguarantee agreements allow the guarantors to earnmarket-rate returns on their investments whilefacilitating further third-party investments in theborrower. Since the guarantor is exposed to atleast part of the borrower’s risk, the guarantoraccepts a higher risk for the returns that the assetswould generate without securing the borrower’sloan. Guarantees are commonly governed by arelatively standardized arrangement called astandby letter of credit, which can be issued bybanks to enable a guarantor to guarantee the debtof a borrower easily. Banks may extract fees formaintaining guarantee arrangements, and aborrower may compensate the guarantor foraccepting additional risk.

Loan guarantees have been a feature of lendingand international development for years, andblended value investors have explored a variety ofinnovative ways to apply guarantees in theirinvestments. Dating back at least as far as 1984,when ACCION International launched its BridgeFund (which offered loan guarantees that helpedLatin American MFIs borrow from commerciallenders), investors have pledged their assets to

Credit Guarantees and Enhancements: Flexible Catalysts for Blended Value Investment


guarantee and thereby accelerate the work ofblended value-generating projects.18 When appliedto blended value investments, a guaranteearrangement can generate social returns byfacilitating and reducing the cost of financing forblended value projects. Furthermore, aguaranteeing entity may provide technicalassistance or consulting to help the investmentsucceed.

It should be noted that, in the United States, loanguarantees structured as standby letters of creditdo not receive any favourable tax treatment whencommitted to philanthropic investments (unless theguarantees are drawn upon, in which case theymay in fact receive different tax consideration).Luther Ragin, Jr, Vice-President for Investments atthe F.B. Heron Foundation, a noted leader inblended value investing in the United States,indicates that such tax treatment has prevented theloan guarantee from seeing more widespreadapplication in US domestic blended value investing.Nevertheless, Ragin notes that the John D. andCatherine E. McArthur Foundation, the Annie E.Casey Foundation, and a number of otherfoundations in the United States have supportedthis type of strategy to achieve financial leverage.19

Characteristics of a Blended Value LoanGuarantee

While the loan guarantee structure is versatile, itcan only be applied to a project that can beleveraged with debt; that is, the project must haverelatively predictable cash flows. A loan guaranteemight be used to launch a new project that may besomewhat speculative. The histories ofmicrofinance bond offerings and loan guaranteesare profoundly intertwined (as noted in the sectionof this paper addressing innovations in debtfinance), and loan guarantees were essential to thefirst issues as well as some of the most recentlyoffered securities.

Loan guarantee arrangements are suitable in avariety of situations. Specifically, they can be usefulto spur investment in new financial products, thelikes of which mainstream commercial lenders havenever seen. Another advantage of loan guaranteesis that they can reduce exposure to currencyfluctuations and, in the process, shift exposurefrom the borrower to the guarantor. Under thisarrangement, one need only convert currencies inthe event of a default that results in a capital call.

Introduction to the Blended Value LoanGuarantee Case Studies

The following case studies demonstrate a variety ofways loan guarantees and similar approachesmight be applied to international blended valueinvesting. The first example, Nurcha, a SouthAfrican low-cost housing finance company,demonstrates how a guarantee may be used toovercome market inefficiencies and spur thedevelopment of an entire economic sector. InNurcha’s ten years of operation, the company’s useof loan guarantees has evolved as both thecompany and the low-cost housing sector havematured. While many of the examples cited thus farhave supported microfinance as the fundamentalvehicle for creating value, Nurcha demonstratesthat these blended value investment strategies caneffectively support other fundamental investmentstrategies.

The second case examines a fund initiated byDeutsche Bank to encourage the growth ofmicrofinance institutions. The vehicles deployed bythe Deutsche Bank Microcredit Development Fundare not, strictly speaking, loan guarantees, but theyserve a similar function. Deutsche Bank’sprogramme demonstrates a replicable model forenhancing the growth of either MFIs or similarfinancial institutions operating in other sectors.

The third case explores how MicroCreditEnterprises has made the loan guarantee strategyavailable to individual and institutional blendedvalue investors. MicroCredit Enterprises effectivelyleverages its guarantees to direct, hard-currencyloans to MFIs. (The capital input is a guarantee,and the fund’s outputs are direct, hard-currencyloans, like those of the securitization deals.)Notably, the programme has been developed suchthat it can be easily replicated by other institutionsthrough its “open-source development” model.

While MicroCredit Enterprises leverages itsguarantors’ commitments into direct loans to MFIs,Grameen Foundation USA’s recently launchedGrowth Guarantees programme uses investors’guarantees ultimately for loans in local currencies.(The capital inputs are guarantees, and the outputsare also guarantees, which, in turn facilitate soft-currency loans.)

The fifth case study examines the recently launchedGlobal Commercial Microfinance Consortium,which combines some features of the microfinancedebt offerings with flexible credit guarantees.



Together the case studies demonstrate the flexibilityand leverage associated with guarantee and creditenhancement strategies. In each case, theguarantee encourages institutions working with thepoor to form stronger connections with commercialor mainstream banks that are not necessarilyinvesting with a blended value agenda. In the longrun, these catalysts can eventually render theprojects more viable for investors and help themainstream financial sector understand and workwith the institutions creating blended value throughtheir management of capital.

First Case Study: Nurcha and the OpenSociety Institute20

Today, Nurcha (originally called the National UrbanReconstruction and Housing Agency) is SouthAfrica’s leading institution providing bridge financingfor the country’s low-cost housing sector. After adecade of operations, the company is preparing fora dramatic expansion in its scale and magnitude ofimpact. The company was founded by the OpenSociety Institute and the newly elected governmentof South Africa shortly after the fall of apartheid.From its inception, Nurcha has aimed to expandaccess to housing for South Africa’s poorestcitizens, especially those who suffered terriblyunder apartheid.

Low-Income Housing in South Africa: UnmetNeeds and Broken Systems

Cedric de Beer, Nurcha’s Managing Director and amember of Nurcha’s founding team, recalls theextent to which housing was a politically chargedmatter in the mid-1990s. Apartheid policies hadseverely restricted where people could live, anddisplacement and property rules ensured that manypeople of colour could not settle in habitable andsafe communities, let alone build equity in realassets. De Beer, his colleagues in theJohannesburg city council, and a group ofprogressive bankers and community activistsbegan formally grappling with the problem ofhousing low-income families as apartheid crumbledin 1992.

The magnitude of the problem was enormous.Several million people lacked stable housingarrangements, and no plausible plan existed tohouse them. At that time, the conservative SouthAfrican banking system was cautious aboutfinancing low-income families. Private philanthropy

did not appear up to task of resolving all aspects ofthis tremendous problem and it was not clear thatthe government would ever be able to tackle theproblem alone. De Beer and his colleaguesrecognized that a market-based solution would berequired, and could eventually be linked to themainstream capital markets.

When apartheid fell, the newly elected Mandelagovernment found itself with a raft of monumentalsocial and economic problems in addition to themassive housing gap between blacks and whites.The government had to improve education,address the lack of employment opportunities forblack South Africans, build fully participatorydemocratic institutions, and confront myriad otherproblems. De Beer suggested the new governmentneeded to produce a “quick win” to demonstratethat it could tackle some of these looming issues.Relative to other seemingly intractable problems,low-income housing appeared to be closest thingto that quick win. The returns on investments in thissector would become evident more quickly than inother sectors, and outcomes would be morequantifiable. Furthermore, housing sectors all overthe world offered robust and proven markets.South Africa had to discover how to make thoseproven markets function within the context of itsown difficult circumstances.

From 1995 the government offered subsidies forhousing low-income families and worked todevelop a market in low-cost housing mortgages.21

Nevertheless, houses and residential communitiessuitable for low-income families were simply notbeing built. The banking and construction sectorsboth feared that the rule of law was too weak inthese communities to extend credit in them.Originally a means of protesting apartheid, atradition of civil disobedience had seized thetownships during the 1980s and 1990s. Residentsfrustrated by the pace of change refused to payutility bills and taxes. After 1994, the fear that suchcivil disobedience would extend to mortgage andrent payments choked off the supply of capital tobuild housing for newly enfranchised SouthAfricans. The risk of loan delinquency seemedoverwhelmingly high to banks that neitherunderstood this market nor had an appetite to takelarge risks in an uncertain economic and politicalenvironment. It seemed like a vicious cycle. Thenew government needed to promote economicsustainability, and home ownership would go a longway toward doing so, but until the townships werestabilized, no one would provide the capital tocreate that housing.



Though Nurcha was involved in variousprogrammes, its core activity was guaranteeingbridge financing for low-cost housing projects.Through 1999, Nurcha would help builders andcontractors secure commercial financing that itthen supported with a 60-70% guarantee. Thus, abank loaning money to a Nurcha-supportedcontractor was guaranteed to recover at least 60-70% of the loan in case the borrower defaulted.These guarantees were subject to a set ofspecifically developed prudent lending protocolsinvolving screening applicants, performing duediligence, and monitoring the loans.

A Victim of Its Own Success

To the great benefit of poor South Africans, theNurcha-facilitated lending model introduced a floodof capital into the low-cost housing sector. By1999, Nurcha had financed the construction ofover 50,000 new housing units. With the loanguarantees in place, the risk-reward profile becamemanageable, and low-cost housing contractorswere able to find bridge financing. By most counts,Nurcha and South Africa’s low-cost housing marketappeared to be an unmitigated success—until thewave of economic and currency crises of the late1990s hit South Africa in 1999.

In three months, the over-draft rate of Nurcha-supported projects rose by more than 50%. TheSouth African Rand fell in value relative to othercurrencies, and domestic South African inflationinterest rates shot up. When low-cost housingcontractors could not manage their interestpayments in the inflationary environment, defaultsquickly mounted, and the banks withdrew fromlending with Nurcha. In the case of one majorlender, many loans had not been issued inaccordance with pre-established protocols, andthese claims against the guarantees were rejected.While Nurcha was fortunate in that its guaranteereserves were not overwhelmingly exposed, thebanks’ losses led them to exit the low-cost housingconstruction market dramatically more quickly thanthey entered.

By 2000, Nurcha was faced with a dilemma. Withits guarantee programme, it had proven thatlending to low-cost housing projects could be bothprofitable and vastly beneficial to low-incomefamilies. Thanks to its willingness to accept riskwhen most banks viewed the risks as untenable,Nurcha’s work eventually revealed the lower cost ofrisks associated with those loans. Nevertheless, thebanks continued to misprice the risk, convinced

An Approach to Breaking the Vicious Cycle

Investor and philanthropist George Soros madegrants in South Africa in the 1970s, but he did notcontinue in the 1980s and early 1990s. Theelection of the Mandela Government in 1994opened opportunities for Soros to again invest inSouth Africa. In consultation with trusted adviser DrVan Zyl Slabbert, Soros’s Open Society Institute(OSI) began seeing philanthropic investmentopportunities in South Africa.22 Slabbert suggestedto de Beer that Soros might invest in a low-costhousing catalyst, as long as it could be set up asan independent entity that would involve thegovernment as an investment partner (but not asthe service provider). Soros and the leadership ofOSI saw an opportunity to normalize economic andfinancial relationships and help the market functionin a place where it had not previously worked.

In due course, Slabbert arranged a meetingbetween George Soros and Nelson Mandela. Whenthey emerged from that meeting, the two hadagreed to co-sponsor an initiative that would helpbring the formal banking sector into low-costhousing finance. They then asked de Beer and hiscolleagues, in consultation with Slabbert andrepresentatives of the OSI, to determine thestructure and strategy of this new entity.

Founding Nurcha

Officially founded in February 1995, The NationalUrban Reconstruction and Housing Agency(eventually shortened to Nurcha) was born of theirdeliberations. OSI and the government of SouthAfrica each contributed US$ 5 million in grants tofound and initially capitalize the company. OSI alsopledged a loan guarantee of up to US$ 50 million,with a required 3-to-1 match; that is, Nurcha hadto raise US$ 150 million in guarantees in order toaccess the full US$ 50 million offered by OSI.Nurcha successfully raised matching guarantees asrequired, but by October 2005 it had drawn downno more than US$ 20 million of the available OSIguarantee.

Using OSI’s loan guarantee as a catalyst, Nurchabegan to guarantee loans from South Africancommercial banks to low-cost housing developersand contractors. With those banks leery of lendingto developers, whom they thought especially riskyborrowers, the banks initially required significantfully secured third-party guarantees. Nurcha’smandate was wide: to “encourage broad bankinginvolvement in the low-cost housing market.”



that financing low-cost housing was an exceedinglyrisky proposition. In truth, had the lending processbeen more disciplined, the banks’ exposure to thelow-cost housing sector would have beensignificantly insulated from macroeconomicchanges.

Nurcha’s Business Model Evolves

If you know that the lending can be profitablewithout being too risky, and you have the financialresources to manage the remaining risk, the nextstep is obvious: you begin lending directly. In itsfirst five years of cultivating the low-cost housingsector in South Africa, Nurcha had learned a greatdeal about structuring loans, screening applicants,performing due diligence and monitoring bridgefinancing.

Thus, in the early 2000s Nurcha moved fromguaranteeing loans by other lenders to becoming adirect lender itself. Banks, realizing that Nurcha wasmore proficient at lending than they were atmanaging low-cost housing loans, began loaningfunds to Nurcha, which then lent the funds tocontractors and developers. Though Nurcha haddemonstrated its ability to manage risky loans, theguarantees produced by the OSI and otherscontinued to further reduce the company’s cost ofborrowing funds. In October 2005, de Beerindicated that Nurcha was still “working a few oldguarantees out of the system”, but had otherwiseshifted entirely to the direct lending model, whichwas still supported by guarantees from OSI. It nowrelies on partners it calls “intermediaries” toadminister loans, and they perform quality control,manage disbursements, and ensure compliancewith regulations. The intermediaries invest a portionof their own capital in the programme, ensuringthat they will manage projects effectively. Nurchastructures its own loan products, screensborrowers, performs due diligence, and takesresponsibility for initiating work-out proceedings forloans at risk.

Nurcha’s customers range from medium and somelarge construction operations to sole proprietors,including many new entrepreneur contractors,particularly women and black South Africans. Thecompany has developed specific programmes tosupport these entrepreneurs, many of whom havebuilt vital medium-sized enterprises out ofmicroentrepreneurial ventures. Nurcha also

expanded in other directions, launching a variety ofprogrammes to encourage a culture of savings. By2004, the company recognized that its corebusiness was financing low-cost housingconstruction, and it exited those programme areasthat did not reside in that core business. It hasfurther refocused its business by financing theconstruction of community assets such as schools,roads and utilities infrastructure. Its Annual Reportindicates that this expansion “is in line with oursocial mission—sustainable communities not onlyrequire houses but clinics, crèches, and communityhalls as well.” 23

A Dramatic Impact, a Dramatic Expansion

By October 2005, Nurcha had financed theconstruction of over 160,000 homes. Increasingly,the OSI permitted Nurcha some flexibility in theuses to which its US$ 50 million commitment couldbe put. OSI has funded some of Nurcha’s overheadover the past ten years. Stewart Paperin, ExecutiveVice-President of OSI, estimates that each of thosehomes effectively cost OSI US$ 25-30 a piece insubsidizing Nurcha’s overhead. With that trackrecord and the company’s business modelsufficiently refined, Nurcha aimed to scale updramatically. In December 2004, de Beer presentedthat expansion plan to the South African HousingMinistry.

Paperin proposed new structured financing forNurcha that would enable the company tocapitalize the construction of over 190,000 newhomes plus nearly 400 community assets (beyondthe 160,000 houses and other communityinfrastructure projects it had already financed) by2008. De Beer’s report puts the company’sfinancing needs into perspective:

Given the volume of lending projected into the future, it isclear that Nurcha will not be able to depend ongovernment or donor agencies to provide this lendingcapacity free, as grant money. Most of the money willneed to be raised from commercial sources.24

While Nurcha had extensive experience raisingcapital from commercial sources, it sought anequity investment both to build institutional capacityand to improve the company’s balance sheetposition. The portion of the equity intended for thebalance sheet would serve as a first-loss provisionfor the commercial loans that would provide thecapital for Nurcha’s core business. Effectively, theequity destined for the balance sheet will serve as aloan guarantee for the commercial lenders.Nurcha’s track record has significantly reduced the



size of that guarantee relative to the company’sborrowing; nevertheless, the size of that guarantee-like loss reserve further lowers its costs of borrowing.

As the company has sufficiently prepared for adramatic expansion of its business, the South Africangovernment has created an environment that requiresdomestic banks to channel funds to areas of theeconomy that had been historically overlooked bymany commercial banking institutions. Much as theCommunity Reinvestment Act of 1977 encouragedlarge amounts of new capital to flow into communitydevelopment investment in the US, Nurcha hopesthat the banking charter can do the same for SouthAfrica.

The Conditions that Made Nurcha Possible

The Open Society Institute’s Stewart Paperin seesfour fundamental conditions that permit Nurcha tosucceed.1. The Right Management: First and foremost,

Paperin stresses that an organization like Nurchamust be managed by deeply knowledgeablepeople “on the ground”, grappling with theproblems directly and understanding the needs ofthe ultimate recipients of the funds. Trust in thosemanagers is absolutely essential, and theircompetence is the best insurance policy that theguarantee will not be needed.

2. A Sophisticated Financial System: Aguaranteed lending arrangement like Nurcharequires that the partners and customers be ableto move funds easily and inexpensively. Adeveloped consumer financial sector makesmonitoring the loans far easier, thus reducing thelikelihood and cost of defaults.

3. Rule of Law: Nurcha could not operate in acountry where contracts are not enforceable orwhere egregious political or social unrest couldimperil the financial industry. These characteristicsaffect the fundamental quality of investments,thereby making them more (potentially prohibitively)expensive to guarantee.

4. Political Will: Though Nurcha is not a governmentprogramme, the South African government hasbeen very involved in founding it and in providingan environment in which it can operate. In additionto the US$ 5 million start-up financing, thegovernment has also contributed guaranteestotalling nearly US$ 15 million. Furthermore, thegovernment supported the industry in a variety ofways, including making mortgages available tolow-income families.

While Paperin believes that the approach might beapplied in a number of other economicdevelopment situations where risk is notappropriately priced, others in his organization arenot as sanguine about the model’s potential forreplication. While the four conditions above arestringent, it is the first that many think will be thehardest to overcome.

Concluding Observations

While loan guarantees continue to facilitateNurcha’s role in financing the low-cost housingindustry, they have become less central to Nurcha’sability to meet its mission—and this conditionsuggests the long-term successful application ofthose initial credit enhancements. As Nurcha, itssuccesses and failures revealed the true risksassociated with its customers and lendingproducts, the commercial markets wereincreasingly able to price that risk. In turn, Nurchacould reduce the credit enhancements as investorsbecame increasingly comfortable with theinvestments’ sound underlying economics.

Second Case Study: Deutsche BankMicrocredit Development Fund 25

Deutsche Bank’s Microcredit Development Fund(DB-MDF) has extended the loan guarantee modelto several institutions and has made such vehiclesaccessible to donors.

The Basic Structure of DB-MDF

In 1998 Deutsche Bank (DB), in partnership withclients from its private bank, established a fund ofdonated capital that it invests as de facto loanguarantees. DB’s clients make donations to thefund, but the fund intends to reuse that capitalthrough an innovative investment strategy for thebenefit of MFIs that lack access to adequatecapital. DB-MDF’s goal is to strengthen linkagesbetween MFIs and their local lenders.



DB-MDF makes deeply subordinated, non-amortizing loans at concessionary rates (1 to 3%).The loans have a one- to five-year maturity,depending on the circumstance. The fundstipulates that these loans are not to be used tofund overhead or to be re-lent to clients; thus, theycan be maintained as hard-currency deposits. Theyare intended to improve the MFIs’ balance sheetposition and augment loss reserves so that theycan more easily borrow funds from local banks.Much as OSI required Nurcha to leverage itsguarantee, DB-MDF requires its MFI investments tomatch the loans with additional borrowing at a ratioof at least 2:1. The fund does make exceptions inparticular circumstances as long as the borrowercan achieve the desired ratio within two years.Furthermore, the MFIs can often earn market rateinterest that exceeds the concessionary rate atwhich it secures those funds from DB-MDF.

DB’s Community Development Group in New Yorkmanages the fund, screening for MFIs that can usethese products to reach economies of scale thatwould otherwise be unavailable to them. Acting asfund managers, the Community DevelopmentGroup has developed expertise in the field ofmicrofinance, and it has used that expertise tolaunch other innovative investment opportunitiesthat direct capital to MFIs.

DB-MDF began strictly as an American not-for-profit, accepting donations (with a minimumamount of US$ 50,000) from American clients. Theenthusiastic response to the fund has led DB toexpand the programme to Europe and the UK.Recently, DB-MDF has started acceptingprogramme-related investments (PRIs) fromfoundations. The fund makes loans in the US$50,000 to US$ 150,000 range, with mean loaninvestment of about US$ 125,000. In its first fiveyears of existence, the fund had invested andreinvested over US$ 3 million, which, it reports,enabled over US$ 42 million to be leveragedthrough additional financing. The fund has madeloans in 18 different countries around the world.

Placing DB-MDF in Context

While the DB-MDF strategy is not, strictly speaking,a loan guarantee, in many ways it functions verysimilarly. First, it has demonstrated the successfulapplication of relatively sophisticated financialinvestments to small, often unregulated MFIs thatwould not likely have access to mainstream capitaland that need assistance forging relationships with

the local banking sector. The success experiencedby DB-MDF suggests a variety of ways that themodel might be altered to suit MFIs and investors.

Furthermore, it has demonstrated that the privatesector can assist smaller, riskier MFIs. Though thefinancial product is funded by donations, a similarmodel might deploy blended value investments(likely concessionary rate loans) for a similarpurpose. (The lack of favourable tax treatment forthis sort of investment could limit the appeal formany investors.) One might also be able to changethe characteristics of the loans to the MFIs so thatthe cash flows permit a variety of other investmentproducts.

Third Case Study: MicroCredit Enterprises26

Like DB’s Microcredit Development Fund,MicroCredit Enterprises, LLC (MCE) makes loanguarantee strategies available to individualparticipants, but this programme allows MCE toleverage the assets of guarantors, while allowingthem to retain their capital and invest it. Not only isthis programme among the first to offer aguarantee strategy to a variety of participants, ithas been developed by entrepreneurs employing adecidedly open-source model that makes itsstructure easily replicable and highly scalable. MCEwaives the copyright to its working documents,which are available on its website,http://www.mcenterprises.org, where they can bedownloaded and used as the basis for other similarprogrammes. MCE enables guarantors to leveragetheir liquid financial assets, which can be held atalmost any financial institution, to secure loans toMCE, the proceeds of which are, in turn, loaned toMFIs. The parameters of the guarantee agreementare elaborated in MCE’s ComprehensiveInformational Memorandum and PhilanthropicGuarantee Agreement (both available on MCE’swebsite), which establishes how guarantors’ assetswill be exposed to the risks of default.

MCE: The Organization

MCE was founded by CEO Jonathan C. Lewis as alimited liability company; it is not a non-profit entityas defined by the IRS, but the organization isgoverned by the principle that its residual earningswill not be used to enrich private persons (see LLCOperating Agreement on their website). It haspledged to minimize expenses and to facilitatemicrolending only. Though its officers andprofessional service providers have all worked on apro bono basis to date, MCE will transfer in 2006


to a professional model wherein a small paid staff willsupervise the MFI loan portfolio, conduct duediligence and manage operations. Any expenses,including salaries, are paid out of the spread betweenthe cost of borrowing funds and the interest receivedfrom making loans to MFIs. Any excess earningsbeyond MCE’s operating costs are committed to aloan loss reserve fund that adds a loss cushion forthe guarantors. The programme, described in detailbelow, is not an investment opportunity: theguarantors’ capital is at risk as it secures MCE'sloans, and the guarantors are not offered any upsidepotential by virtue of their participation in theprogramme. Nevertheless, the guarantors’ assetsfacilitate the flow of capital to MFIs and their clients.

MCE: The Investment Vehicle

Guarantors elect to participate in the programme inUS$ 1 million increments. Each guarantor signs aPhilanthropic Guarantee Agreement and otherdocumentation in which he or she pledges the assetsin a specific brokerage to guarantee loans of up toUS$ 600,000 to MCE, which then re-loans the fundsto MFIs. The guarantors maintain control of theirassets, though they must remain in “permittedinvestments”, which, the Information Memo explains,“typically are limited to cash, mutual funds, stocks,investment grade bonds, money market funds,publicly traded shares of real estate investmenttrusts." 27 The assets must be relatively liquid in casethey must be sold to repay a defaulted MFI loan.Guarantors also pledge to keep the value of theirguarantee accounts at a minimum value of US$ 1million. Any gains or losses in an individual’s accountaccrue to the investor. In essence, the guarantor cancontinue to manage his or her money as usual,earning full market-rate returns, while at the sametime allowing MCE to leverage his or her assets byfacilitating the flow of capital to MFIs. Guarantors doaccept a pro rata portion of the risk that MFIs defaulton their loans from MCE, which could cause MCE todefault on its borrowings, which, in turn, could createa capital call on the guarantors.

MCE’s model allows it to partner with a number offoundations and financial institutions to borrow fundsthat are collateralized by guarantors’ accounts. Toloan funds to an MFI, MCE borrows first from thecollaborating foundation or financial institution thatextends it the most favourable terms, though itpledges to distribute any losses pro-rata among all ofits programme guarantors. Assume, for example, thatMCE has three US$ 1 million guarantee accounts atBank A and one US$ 1 million at Bank B. If Bank B

would loan funds on more favourable terms thanBank A, MCE may borrow US$ 600,000 from BankB. However, each of the four guarantee accounts isexposed to losses up to US$ 150,000. The terms ofMCE’s agreements with collaborating financialinstitutions stipulate that the financial institutions willextend credit for up to 60% of the US$ 1 millionminimum for each account. Thus, if MCE had US$10 million in loan guarantee accounts, it couldborrow up to US$ 6 million. Accordingly, the loansare significantly overly collateralized, providing thepartnering foundation or financial institution withgreater security, which, in turn, may provide MCEwith more favourable loan terms that can be passedon to MFIs.

Once MCE has borrowed funds in the US, it thenmakes and administers loans to MFIs. MCE’s duediligence and loan monitoring is shared betweenMCE and established MFI networks. Essentially, MCEtakes responsibility for a thorough fiscal analysis ofeach MFI loan application (a “desk review”), butprimarily invites referrals or “MFI loan nominations”from established and respected MFI networks.28

Avoiding the costs of a field investigation, MCE tapsinto longstanding MFI alliances and workingrelationships in order to make the qualitativeassessments about management, board,governance and transparency.

MCE has developed relationships with manynetworks on different continents with different lendingphilosophies or approaches, all of which presentopportunities for loan portfolio diversification. Lewisindicates that MCE intends to loan funds primarily toMFIs that serve the poorest client populations and toMFIs that do not have the same access to capitalthat the first tier MFIs have. Though the MFIborrowers may not have the same access to capital,MCE will not compromise on their financial heath; allmust be financially sustainable or demonstrablymoving toward self-sufficiency. The programmemakes loans to MFIs with a range of legal structures(private, cooperative, non-profit, etc.). Furthermore,MCE carefully monitors the loans, ensuring that itdoes not lend beyond the MFIs’ capacity to absorbnew debt capital.

MCE’s loans to MFIs typically mature in three yearsand have very flexible payment terms. Most of MCE’sloans will be directed to MFIs serving the poorestmicroborrowers, a practice that will generate themost blended value leverage. Lewis estimates that aUS$ 1 million guarantee can translate into as manyas 20,000 microloans in the first year alone.




Proof of Concept

After demonstrating the general concept bysecuring seven US$ 1 million guarantors in 2005,MCE temporarily stopped actively seekingguarantors. Though MCE can borrow up to US$4.2 million against those accounts, it aims to makeloans to MFIs totalling US$ 3 million in its first fullyear of operation, commencing 1 January 2006. Ofthe first seven guarantors, two are not-for-profitinstitutions (Oxfam America and Freedom fromHunger) that have pledged portions of their reserveaccounts and the other five are high net worthindividuals. In the next year, Lewis plans to secureguarantees totalling US$ 20 million, and within afew years, he envisions that the guarantee pool canreach US$ 100 million dollars—money that will beworking financially for its guarantors whilefacilitating US$ 60 million in new capital flows toMFIs.

Surprisingly, the first loan to MCE was difficult tosecure. Though the loans to MCE are over-collateralized as mentioned earlier, several majorbanks balked at participating in the programme.Their concerns were not related to financial risk;instead, they were related to the reputational riskassociated with these new types of loans to a newentity without a proven track record. The banksoffered to make the loans only if the guarantorswould be jointly and severally liable for the entireloan (in excess of their US$ 1 million collateralaccount value), which would essentially allow thelender to choose which guarantors it would pursuein the case of an MFI loan default. Such anarrangement would have violated one of thecornerstones of MCE's programme, which is thatguarantors can participate in the programme andincur relatively finite risks that will be shared amongall of the guarantors.

Instead, MCE established a new borrowing model,sourcing a US$ 3 million loan from the CalvertSocial Investment Foundation. According to Lewis,as the collateral base grows, MCE will diversify itslenders by establishing similar borrowingrelationships with other foundations and financialinstitutions, depending on where it can secure themost favourable terms.

In January 2006, MCE made its first loan, directingUS$ 700,000 to an MFI in Bolivia with an averageclient loan size of US$ 185.

Building the Product

Professional Service Providers

Lewis and MCE worked very closely with JohnFerguson, a partner resident in the New York officeof Goodwin Procter LLP. Ferguson and hiscolleagues, all financial transaction and capitalmarkets specialists, were eager to participate in theproject, which offered a relatively rare opportunityto deploy the partners’ financial transactionsexpertise in a pro bono setting. In addition toprofessional and functional input from multiple lawfirms, financial professionals, graduate studentsand others, MCE drew deeply on the opinions andinterests of potential guarantors. Many of theprogramme’s features arose directly from theguarantors’ input. Uniting all of these contributors,Lewis reports, are both a drive to helpmicroborrowers and a desire to build a robust, newfinancing strategy that can be freely adopted byother practitioners.

Characteristics of the Guarantee Agreements

Duration of the Guarantees: Initially, Lewis hadenvisioned a relatively short-term guarantee thatwould require minimal notice (possibly as short asonly 90 days) before a guarantor terminated theagreement. Prospective guarantors eventuallypersuaded him to make the standard guaranteeslonger term. As a result, the guarantee agreementsnow require that a guarantor provide 18 months’advanced notice before ending the agreement andexiting the programme. 12 months after the initialnotice, the guarantors may remove 50% of theircollateral assets, and six months later they maywithdraw the remaining 50%. This arrangementensures that all guarantors will have relativelyconsistent, predictable risk exposure to defaults.When a guarantor exits, the risk exposure for theremaining guarantors increases until theoutstanding loan balance is decreased or additionalguarantors are added. The 18-month provision alsogives MCE the ability to line up new guarantors toreplace exiting guarantors or to manage its loanportfolio so that guarantors’ risk exposure remainsstable.

Loan Performance Contingency Account: Atthe suggestion of the guarantors, MCE hasnegotiated with its MFI networks to provide a fivepercent first-loss reserve for any loans that theyadminister. This provision offers some protection



against moral hazard, the risk that the MFInetworks will channel capital to their own MFIpartners or allies that can least afford to repay it.With their own capital at risk, the networks haveincentives to carefully monitor MFI loans.

Ponzi Protection: MCE and potential investorsintentionally tried to determine how this investmentvehicle might be misused if applied maliciously orincompetently. By making all of their work open-source, the guarantors and MCE effectivelypledged to make the structure available to anyonewishing to use it, whether for good or ill. They wereconcerned both with the potential that peoplecould do harm with their new structure and withthe potential that this new strategy could be sulliedby such harm.

One of their greatest concerns was that thisstructure could be used, more or less, as apyramid scheme. An unscrupulous guarantee fundcould acquire new guarantors to support new loansthat would be used to pay back non-performingloans (instead of taking a loss and invoking acollateral call on existing guarantors). To preventthis and to demonstrate the integrity of the model,MCE forces itself to realize and allocate losses toguarantors if a loan to an MFI is past due beyond acertain grace period. Though it has not happenedyet, MCE can imagine a case in which it recognizesa default on a non-performing loan that is laterrecovered. Should such an event happen, it willrefund any related collateral calls it makes on itsguarantors.

Standby Letter of Credit Functionality: MCEand its prospective guarantors obviously loathe thepossibility of defaulting on loans to foundations orbank lenders. If a loan to an MFI does not perform,MCE is the party that defaults on its loan to thefoundations or banks. To avoid MCE’s defaulting onone of its borrowings, the guarantee agreementincludes a provision that resembles a standby letterof credit. The guarantors pledge to fund loandeficiencies (pro-rata) above any first lossprovisions proffered by the MFI. Thus, theguarantors can meet any collateral call with liquidassets not held in the guarantee account. In theevent that losses get allocated to guarantors andthe guarantors cannot honour the standby letter ofcredit feature of the agreement, MCE would thenbe forced to default on one or more loans, and onlythen would the lenders to MCE seek directrecourse against the guarantors and their pledgedaccounts.

Future Opportunities

Beyond dramatically increasing the scale of its ownoperations, MCE sees vast opportunities for thepooled guarantee model to magnify the flow ofcapital to projects in developing economies.Ferguson suggests that multinational banks would bewell-situated themselves to create a similarprogramme (alone or in partnership with MCE) andthen, with its existing customers and internationalinfrastructure, execute it more efficiently. With thosestrengths, a bank has the potential to poolguarantees from many more clients, which, in turn,might permit a smaller minimum guarantee, belowUS$ 1 million.

Nevertheless, a potential limitation may eventually bethe availability of creditworthy MFIs capable ofproductively absorbing more debt capital, especiallydebt capital that is sourced internationally.Furthermore, the still-developing infrastructure todeploy and monitor MFI loans may not be able tokeep pace with the new capital entering the sector. Itshould be noted that this constraint is not bindingnow. Some actors in the microfinance capitalmarkets do not believe that the “boots on the groundconstraint” will become a major concern. Theysuggest that as more capital continues to flow intothe sector, the MFI networks and other infrastructureproviders on the ground will expand their work atleast as quickly.

Fourth Case Study: Grameen FoundationUSA’s Growth Guarantees Programme 29

Grameen Foundation USA (GFUSA) recentlylaunched its Growth Guarantees (GG) programme,which is structured similarly to MicroCreditEnterprises’ guarantee programme. However,GFUSA’s programme uses those dollar-denominatedguarantees to support local commercial bank lendingand capital markets transactions in local currencies.The lending products that GG makes available toMFIs are very flexible, but all of them intend to forgeconnections between the MFIs and their local banksor other local investors.

The Origins of GFUSA-GG

The idea for the Growth Guarantees programmearose from a meeting of high net worth individualswho had already supported GFUSA’s work. Theseindividuals came together to develop new ways tochannel capital into the sector, particularly intoGFUSA-affiliated MFIs. From this meeting, the pooledguarantee fund was born.



GFUSA’s Capital Markets Group, which is led byJennifer Meehan (whose work is cited elsewhere inthis study) manages the GG programme. Donor-guarantors’ minimum guarantee is US$ 1 million,pledged for five years to Citibank in the form of astandby letter of credit (SBLC).30 The donor-guarantor’s SBLC is backed by a portfolioapproved by the donor-guarantor and the issuingbank. Donor-guarantors continue to realize thereturns on their portfolios. These guarantees arepooled to support SBLCs issued by Citibank (in theamount of US$ 100,000 to US$ 5 million and fordurations up to 4.5 years) to financial institutions inthe countries where the MFIs operate. Grameencharges the MFIs benefiting from GG-arrangedfinancing a 1.5-2.5% annual fee for providing theguarantee and associated services.

Local Currency, Local Connections

The SBLCs enable a variety of financing strategiesthat aim to build relationships between MFIs andtheir local banking institutions and other capitalmarkets players. GFUSA believes that the MFIsgain by learning more about their local suppliers ofcapital. Not only should local banks learn moreabout the microfinance sector, GFUSA hopes thatCitibank-supported guarantees will eventually helpthe local banks price the risks associated withloans to MFIs and other financing organizationsmore appropriately, thereby making more capitalavailable to all.

In the MFIs’ domestic markets, theGFUSA/Citibank supported financial transactionscan take a variety of forms, including direct loansfrom local banks to MFIs, securitization of MFIportfolios (wherein the GFUSA/Citibank SBLCoffers investors some manner of first-loss cushion),partnerships between MFIs and local financialinstitutions, and any number of other potentialtransactions. These guarantees are vetted andmanaged by the GFUSA Capital Markets Groupand approved by an independent investmentcommittee.

GFUSA’s capital markets group has developed arobust screen for “high growth, professionallymanaged MFIs that have a documented povertyfocus."31 While many of the products and serviceswill go to MFIs already associated with Grameen,GFUSA has also developed a strategy to work withpoverty-focused MFIs outside of the GFUSAnetwork.

Regardless of how those products are structuredfor the MFIs, GFUSA stipulates that they must beleveraged at a minimum rate of 2:1. Furthermore,those financings must be devoted to growththrough new loans, not to overhead or capitalexpenditures. Ultimately, GFUSA estimates thatUS$ 50 million in guarantees could guarantee up toUS$ 300 million in microloans.32

Investor enthusiasm for the GG product propelledthe first closing in October 2005 to US$ 31 million,US$ 11 million more than its managers hadanticipated. GFUSA aims to reach US$ 50 million inguarantees by its second closing in 2007.

Fifth Case Study: Global CommercialMicrofinance Consortium33

Organized and placed by Deutsche Bank’sCommunity Development Group, which administersthe bank’s Microcredit Development Fund, theGlobal Commercial Microfinance Consortium isremarkable for its flexibility with respect to financingMFIs, its capital structure sophistication, and itsdegree of collaboration between major financialinstitutions. Ultimately, the Consortium bodes wellfor the future involvement of mainstream investorsin financing international blended valueinvestments.

The Consortium closed in November 2005 at US$75 million in committed capital. The press releaseannouncing the consortium’s closing lists 26consortium partners.34 They include mainstreamfinancial institutions, foundations, sociallyresponsible asset managers, pension funds, state-supported aid agencies and high net worthindividuals. (See box for the complete list ofinvestors.) The Consortium’s sophisticated structurepermits the participants to select the risk-rewardprofile of their investment. By the time that thefund’s closing was announced, it had alreadycommitted US$ 30 million to MFIs in Peru, Kosovo,Nicaragua, Azerbaijan, Columbia, Pakistan,Mozambique and India.35


made in hard currency, while interest payments canbe in hard or local currency, depending on thenature of the arrangement. See figure 3 for theConsortium’s visual representation of this financingarrangement.

Deposit Structures: These investments are thesame as used by the Deutsche Bank MicrocreditDevelopment Fund. Figure 4 presents theConsortium’s graphical representation of thisstrategy.

Loan Guarantees: Working through commercialbanks that issue standby letters of credit, theconsortium will also make deposits to serve asguarantees, much as MCE’s and GG’s guarantorsfacilitate investments. See figure 5 for theConsortium’s representation of thesearrangements.


Flexible Financing for MFIs

Similar to GFUSA’s Growth Guaranteesprogramme, the Consortium structures its financialproducts specifically to suit the needs of borrowers(and the regulatory environments in which theyoperate). Though not limited to these examples, theConsortium will deploy the following financingmechanisms.

Co-Lending: Under such an arrangement, theConsortium provides a portion of the capital tomake local-currency loans through local banks.Such arrangements bring new capital to MFIs whilesharing the exposure to foreign currency fluctuationwith the local bank. Local banks initiate and servicelocal currency loans to MFIs. The consortium thenpurchases a portion of those loans from the localbank, stipulating that principal payments must be


Figure 3: Co-Lending Mechanisms

Source: Deutsche Bank Global Commercial Microfinance Consortium Investor Presentation,28 November 2005

1. Agence Française de Développement2. AXA Group3. Calvert Social Investment Foundation4. CNP Assurances5. Deutsche Bank6. Geisse Foundation7. General Board of Pension and Health Benefits of the

United Methodist Church8. Gray Ghost Fund9. Hewlett-Packard10. Kaminer Foundation11. Left Hand Foundation12. Merrill Lynch13. MMA

14. Munich Re15. Rauenhorst Foundation, 16. Standard Life17. State Street Corporation18. Storebrand19. The Church Pension Fund20. The Co-operative Bank Plc 21. UK Department for International Development22. US Agency for International Development23. David Fitzherbert24. Elizabeth and Steve Funk25. Deepak Kamra26. Janet A. McKinley

Global Commercial Microfinance Consortium Members


Just above the DFID’s first loss provision are ClassB equity holders, who committed a total of US$ 5.5million. (Deutsche Bank has also committed US$ 1million to this tranche.) In the event that loan lossesexceed US$ 1.5 million, Class B equity holders willabsorb the losses to the limit of their capitalcommitments. In exchange for this exposure, ClassB equity will earn a yield of up to 12% annuallyafter the senior tranches are satisfied.

Capital Structure

The essential structure of the fund has a US$ 60million tranche of five-year notes cushioned bythree tranches of equity totalling US$ 15 million.(Please see figure 6 for the Consortium’s capitalstructure diagram.) The most deeply subordinatedtranche is a US$ 1.5 million first-loss provision inthe form of a deposit by the UK’s Department forInternational Development (DFID). Any residualfunds in this tranche that were not absorbed aslosses over the Consortium’s five-year life will becommitted to future similar financings.


Figure 4: Deposit Structures


Figure 5: Loan Guarantees


Senior to the Class B equity is a Class A equitytranche, totalling US$ 8 million in committed capital.Class B equity holders are next in line to receive lossesshould they exceed US$ 7 million. They arecompensated for this risk by earning a yield of up toseven percent, distributed periodically after the noteholders are satisfied.

The notes in the senior tranche will pay the LondonInterbank Offer Rate (LIBOR) plus 1.25%. Not only arethe notes cushioned by US$ 15 million in subordinatedtranches, USAID has pledged a US$ 15 million lossguarantee on top of that provided by the equitytranches. Thus, the consortium can incur up to US$30 million in losses before the note holders lose any oftheir principal. Even in the event of total loss, noteholders will still benefit from the USAID guarantee,receiving at least one-fourth of their principal.

Scale

While not the largest MFI-financing offering(BlueOrchard’s fund totalled US$ 87 million), the scaleof this offering is significant. Asad Mahmood, Directorof DB’s Community Development Finance Group andGeneral Manager of DB’s Microfinance Funds,suggests that size of the fund plus the resources

afforded by the consortium partners will facilitatehis group’s due diligence and monitoring of theConsortium’s investments. That scale advantagefurther enables the consortium to engineer financialproducts best suited for the MFIs in which itinvests.

Mahmood and his colleagues had originallytargeted a fund size of US$ 50 million, which hadgrown to US$ 75 million by November. Theoversubscription bodes well for MFIs that needaccess to capital, and it suggests significantdemand for sophisticated and versatile large-scaleofferings. The deal size remains small formainstream investment banks; nevertheless, theconsortium members include Deutsche Bank,Merrill Lynch and Calvert Foundation, all of whichhave the capacity to structure future investments.Many of the other consortium members, includinginsurance companies and pension funds, areinstitutional investors of large amounts of capital.Mahmood believes in convening and collaboratingwith diverse actors and investors, and he suggeststhat one function of the consortium is to bringtogether investors, bankers and other parties toexchange ideas and build momentum behind thissort of innovative financing.



Figure 6: Global Commercial Microfinance Consortium Capital Structure

Source: Deutsche Bank Global Commercial Microfinance Consortium Investor Presentation, 28 November 2005


The flexibility with which the Consortium deploys itscapital indicates how accommodating financialinstruments can be when they combine aspects ofdebt, equity and the risk-sharing of creditguarantees. It does not take a very large leap toimagine how this sort of sophisticated financialengineering could be applied to other developmentfinance projects including low-cost housing finance,the construction of utilities infrastructure indeveloping economies, or any number of otherinternational economic development projects.

In conclusion, the loan guarantee is a powerful andversatile tool. The case studies in this sectiondemonstrate that loan guarantees generate morethan money: they forge partnerships, eventuallyhelp mainstream financial institutions understandand accurately price risk, and demonstrate blendedvalue projects’ viability—all while giving theguarantor market rate returns.

Concluding Thoughts

Mahmood argues that most participants are notbuying Consortium’s product because it offers anappealing financial risk-reward opportunity orbecause the investment’s value will be uncorrelatedwith other investments. He sees investors seekingproducts like the Consortium because they careabout where their capital goes, and they want todeploy it for good. His observation suggests afuture for blended value investing that will includemore, larger, increasingly sophisticated investorsseeking multiple returns and deploying their capitalin ways that ever-more accurately reflect amultidimensional approach to value.



Introduction

The universe of international blended value privateequity investments is enormous, ranging frominformal micro-capital investments by individuals allthe way to professional private equity fundsinvesting hundreds of millions of dollars indeveloping economies. Investment strategies rangefrom social-value maximizing approaches toblended-value investment methodologies to strictlyprofit-maximizing investing. Given the broad rangeof investors, funds and deals in this realm, thissection cannot be exhaustively comprehensive.Instead, it examines a range of methods deployedin the United States, followed by three very differentinternational investment approaches, eachdeliberately adapting standard private equitypractices to generate blended value returns.

The Crucial Role of Private Equity Investment inDeveloping Economies

Private equity investment is essential to buildingrobust private sectors that create employment,improve living standards and produce tax revenues.Equity investors are usually more risk-tolerant thandebt investors. They commit their capital for anuncertain term and have a residual claim onearnings only after all debt obligations have beensatisfied. Equity investors face a host of other risks,several of which are explored below.

Equity investments are particularly suitable for earlystage companies that will have unpredictable cashflows and accordingly are not suitable for debtinvestments. Unlike lenders, who maintain anarm's-length relationship with their borrowers inmost circumstances, private equity investors canmitigate some of their risks by exercising a largemeasure of influence or control over theinvestments, and such investor engagement oftenencourages transfers of best practices andorganizational capacity building. That involvementcan help businesses build better, more efficientbusiness processes, improve their corporategovernance, forge partnerships with otherbusinesses, and work more productively with otherlocal institutions. The investors can also advocatefor and/or support the entrepreneur’s efforts tocreate, social and environmental value that, in turn,often builds enhanced economic value.

A Survey of Risks and Challenges

Private equity investors in developing economiesface a variety of formidable risks that tend to bemore severe than similar investments in developedeconomies. Savvy investors can deploy tactics tominimize some of these potential hazards, butmany of them cannot be eliminated; all of them canchallenge the likelihood of fully risk-adjusted marketreturns.

Corporate governance: Many cultures andeconomies lack a tradition and expectation ofcorporate governance that protects allstakeholders. Small enterprises particularly areoften not subject to regulations that wouldencourage optimal governing practices. Remoteinvestors not steeped in local culture may find itdifficult to implement prudent governance.

Management competence: Frequently,entrepreneurs do not have the opportunities towork in well-run companies before starting theirown businesses. Without widely availablemanagement training or relevant previousexperience, enterprises in developing economiesoften lack well-trained managers.

Multiple ways of extracting value: Developedeconomies have established (and narrowly defined)means of extracting value from specific companiesthrough interest, dividends or a sale of business. Inmany cultures, returns are generated in other ways.Examples include directing business to othercompanies controlled by a business’s principals orhiring family and friends (in the developed world,such practices would be decried as self-dealing orcronyism). Such practices are by no meansconfined to developing economies, but in manycultures, these practices are considered legitimateways of distributing value.

Corruption and graft: Certain countries andeconomic sectors face this obstacle more severelythan others. Operating a business that does notengage in such practices can engender a very realcompetitive disadvantage when competing againstbusiness that do.36

Bureaucracy: In many parts of the world,businesses face great bureaucratic regulatoryhurdles when founding and operating businesses.Particularly when bureaucracy and corruptioninteract, the effect can dramatically chill a country’sinvestment climate.37

Innovations in Private Equity Investing


Country risk - political and macroeconomicvolatility: With less political and economic stabilityin developing countries, private enterprises face agrave range of hazards from coups d’etat tocurrency devaluations. The duration of equityinvestments and the extraordinary difficulty inbuilding currency hedges make currency exchangefluctuations a significant risk.

Rule of law and enforcement of contracts:Many investors take a well-developed code ofcorporate law and a relatively functional judiciary forgranted. Such conditions make contractsenforceable and give recourse to entities that havebeen wronged. Without them, an enterprise mustcarefully attempt to do business only with entitiesthat will honour their contracts and obligations. Inmany emerging economies, the law and judiciaryare not dependable, which increases transactioncosts and risks.

Exits: Realizing a return either through a sale orpublic offering can be especially difficult when suchstrategies are rarely practiced or supported by arobust financial sector. Sales and ownershiptransfers depend not only on the presence ofbuyers and sellers (which may be relatively thin inemerging economic environments), but also requiresupporting professional services and infrastructure,including banking, accounting and legal services.Such support may also be in short supply in lessdeveloped economies.

Innovations in Private Equity Investing


As venture capital (VC) has generated spectacularfinancial value in the United States and otherdeveloped economies, many investors have soughtto deploy risk capital with VC-like models thatdeliberately seek returns in multiple dimensions. Ina number of locations in the United States,innovative blended value investors have sought tolink community development investing to venturecapital.38 These investors make equity investmentsavailable to small enterprises that would createlocal employment opportunities and otherwiseenhance the local communities. As many of thesefunds are dedicated to a specific geographic ormunicipal area, they significantly limit the number ofcompanies in which they can invest. Furthermore,the nature of the returns they seek often renderstheir financial returns concessionary.

The Community Development Venture CapitalAlliance, an investors’ trade association, offers avariety of tools for exploring these investmentstrategies and the funds that deploy them.39 RISECapital Market Report: The Double Bottom LinePrivate Equity Landscape in 2002/2003, publishedby the Columbia Business School’s ResearchInitiative on Social Entrepreneurship (RISE) inJanuary 2004, remains an excellent starting pointfor further examination of blended value venturecapital investing in the United States.40

Pacific Community Ventures

Founded in 1999, Pacific Community Ventures(PCV) has become a leader in the area ofcommunity development venture capital. PCVenhances and invests in businesses that bringeconomic opportunities to low-incomecommunities in California. PCV manages twoventure capital funds, PCV Investment Partners Iand II. The organization also offers “BusinessAdvisory Services”, capacity-building assistance forarea businesses and social purpose enterprisesthat corroborate the organization’s mission.

PCV invests in companies that operate in or nearlow-income communities and employ the residentsof those communities. The investment screenassesses the quality of employment opportunitiesthat the company offers, including the quality ofbenefits and potential for advancement. The fundsmeasure multiple returns on a variety ofparameters, which they then make available to thepublic.41 The fund makes US$ 1 million to US$ 5million in equity investments in companies thatrealize annual revenues of at least US$ 5 million

and have the potential to grow in ways that enrichtheir employees. The funds will invest alone, butoften they invest in syndicates that includeinvestors not using blended value investmentframeworks.

PCV recently realized significant gains whenportfolio company Timbuk2 was acquired by aprivate equity fund. The liquidity event triggeredsignificant cash payouts to local, non-managementemployees, many of whom live in economicallydepressed areas, in some cases doubling annualsalaries. While this sort of event is usually a verygood thing for investors, it rarely touchesemployees.

Environmental and Clean Technology Funds

Another relevant class of venture capital fundsdirects investments at an industry or sector that willgenerate multiple returns. A significant number ofsuch funds direct their capital to renewable energyor clean technology. Many of these funds do notmake substantial changes to the standard venturemodel, and may be managed in a fashion all butindistinguishable from their peers on Sand Hill Roadin Palo Alto, California—the difference, however, istheir focus on leveraging environmental valuethrough the application of market rate capitalinvestments.

Expansion Capital Partners, LLC

Expansion Capital Partners (ECP) investsspecifically in clean technology, which it defines as“[t]echnologies that offer dramatic improvements inresource productivity, creating more economicvalue with less energy, less materials and lesswaste. These technologies significantly lower costand improve profitability, with short paybackperiods."42 Expansion offers a compellinginvestment thesis for focusing on this sector, notingthat these markets are growing quickly, thatcompanies in the space have been under-investedto date, and that venture investments in clean techoffer investors a measure of diversification beyondthe typical venture capital industry foci. Expansionseeks equity investment opportunities in companiesrealizing US$ 2 million to US$ 20 million in revenueswith the potential to grow considerably larger. Itstarget investments range in size from US$ 500,000to US$ 2 million, and the fund aims to realize anIRR in excess of 25% (before subtracting fees andcarried interest). Investors in ECP include an arrayof both individuals and private foundations.

Variations on Traditional Venture Capital


Solstice Capital

With offices in Boston, Massachusetts and Tucson,Arizona, Solstice Capital bills itself as an “early-stage, diversified, positive-impact venture fund”investing in alternative energy, environment, lifesciences, education and information technology.The partners have committed to investing 50% oftheir two funds in socially responsible investments.Solstice notes that “socially responsive investmentscan generate superior venture capital returns andmake a positive contribution to the natural andsocial environments.”43

Solstice is affiliated with Village Ventures PartnerFunds, a network of affiliated venture capitalinvestors focused on investing in Americangeographic areas that have been typicallyoverlooked by venture investors. Village Venturescentralizes many of its partners’ administrative andoperational services, allowing the partners to focuson their core investment responsibilities. Affiliationwith Village Ventures also improves Solstice’s dealflow exposure. Solstice’s two funds, formed in1995 and 2001, manage a total of US$ 85 million.Solstice’s early stage investments tend to range insize from US$ 500,000 to US$ 1 million, and thefirm is committed to syndicating its investmentsand regularly co-invests with other firms.

Blended Value Angel Investing

Many businesses are not suited to venture capital,which, particularly in its established and widelypracticed forms, only invests in a relatively narrowtype of business. Most businesses take too long tomature before a liquidity event, are not likely toachieve the financial return hurdles that VCsrequire, or are in industries that garner littleattention from venture capitalists.

Entrepreneurs not able to secure venture capital willturn to angel investors, individual private equityinvestors who commit their personal capital andassistance to private enterprises that do not meetventure capitalists’ investment profile. In the US,angel financing remains a loosely definedinvestment class that can be difficult to assess.Angel investors have a wide range of motivationsand approaches to their investments, but mostinvest in ventures operating in the industries wherethey have had previous success, where theirhuman capital can be as helpful as their financialcapital.

In the United States, the angel investor capitalmarket, such as it is, in many ways remains aninefficient and somewhat localized market; that is,investors and angel investors are often connectedthrough interpersonal networks, not through anykind of market intermediary. Because an angelinvestor is accountable only to him or herself (anddoes not have a fiduciary duty to maximize financialprofits for limited partners), an angel can invest inventures as they suit him or her. Accordingly, onemight expect that angels would be a fruitful sourceof capital for entrepreneurs deliberately generatingblended returns—if they could find one another.

Investors’ Circle (IC) aims to help blended valueprivate investors find ventures that will corroboratethe blend of returns they seek. Though itsmembers are both individual private equityinvestors and venture-style funds, Investors Circledescribes itself as “a leading social venture capitalintermediary whose mission is to support early-stage, private companies that drive the transition toa sustainable economy. Founded in 1992, IC hasbecome one of the nation’s oldest and largestinvestor networks, and the only one devotedspecifically to sustainability.”44 A brief survey of theInvestors' Circle website will present the readerwith an array of funds making blended-value privateequity investments in the US.

First Case Study: ProFund 45

By the end of 2005, ProFund, the first commercialmicrofinance equity fund, had exited itsinvestments, distributed the profits to its investors,and closed its doors—all according to plan.46 Overthe course of its ten-year life, ProFunddemonstrated irrefutably that one could generateprofits by investing in MFIs even throughexceptionally challenging economic and politicalconditions. Whereas ProFund was the only investorof its kind when founded in 1995, by the time thefund distributed its gains ten years later, at least 20other MFI equity funds had embarked on similarinvestment strategies.47 In 2003, the proliferation ofthis investment strategy led to the creation of theCouncil of Microfinance Equity Funds, amembership organization aiming to advance thefield of microfinance equity investing.48

Not only is Profind’s financial return, at the end ofthe day, an illustrative example, the fund’sadministration and the sponsors’ public “post-mortem” examinations have revealed a variety ofnuanced lessons.




ProFund’s Founding Premises

ProFund was predicated on a clear fundamentalneed: MFIs in Latin America needed more capital.The fund proposed to meet that need through equityinvestments. Between the need and ProFund’ssolution was the fundamental principle that a socialmission and financial value creation are not onlycompatible, but they can be mutually reinforcing.

Sponsors ACCION International, Calmeadow,FUNDES, SIDI and Mr Fernando Romero invested inProFund to generate social returns, to capturefinancial returns, and to demonstrate a model thathad the potential to magnify the social and financialgains created by microfinance. Those sponsorscontracted with Costa Rican fund manager andconsulting firm Omtrix, SA to manage the fund, andOmtrix president Alex Silva became the CEO ofProFund. Silva’s work has been central to thedevelopment of the ProFund approach and he isreferenced throughout the balance of this discussion.

In founding ProFund, the sponsors articulated apreference for equity investments in MFIs for avariety of reasons. First, some MFI managers wouldprefer equity investments, with their longer-terminvestment horizon and lack of regular cashoutflows. Nevertheless, the higher risk associatedwith equity investments made such capital scarcerthan other sources. Second, financial institutions canonly borrow up to a certain multiple of their equityinvestments (a requirement that varies by regulatoryregime), so equity investments can facilitate follow-on debt investments. Third, the equity investmentencouraged engagement and influence that could beexercised through membership on the investees’boards of directors, where ProFund’s directors couldintroduce best practices where appropriate. Finally,in order to accept equity investments, MFIs had toacquire a certain level of sophistication. If an investeeMFI was not already a private financial institution, itwould either need to become one or would need towork with ProFund to craft a quasi-equity investmentstructure. Accordingly, the presence of ProFundencouraged MFIs to become more professionallymanaged.

The Mechanics of ProFund 50

In founding the fund, the investors stipulated thatProFund would have a finite lifespan, ceasingoperations in ten to twelve years after exiting all ofits investments. The requirement forced the fundmanagers to deal with one of the most persistentbarriers to private equity investment in microfinanceand in developing economies in general: the lack ofeasy opportunities to liquidate investments.(ProFund’s operational solutions to this challengeare elaborated later in this case study.) Thefounders also recognized that the fund would onlyspur similar investments if it could demonstraterealized returns for the whole portfolio, andstipulating the fund’s ultimate liquidation guaranteedthat ProFund would produce a conclusive,indisputable initial rate of return (IRR).

According to standard investment funds’ practice,ProFund employed an investment committee thatwas ultimately responsible for investment decisions.The fund’s professional staff uncovered andscreened potential deals, negotiated and thenmonitored investments, identified exits, and servedas a technical assistance resource to portfolioinvestments. Between the staff and investors,ProFund had extensive microfinance experience,and it could assist investees through the full rangeof their financing, strategy and operationschallenges.

Though the professional staff had extensiveresponsibilities, the fund’s charter ambitiouslyrestricted administration to three percent ofcommitted capital. At the fund’s launch, this capafforded ProFund only two full-time professionalstaff (plus an administrative employee and the inputof paid consultants and other professional servicesservice providers). Eventually, when the fund’s sizeincreased (reaching US$ 22 million in 1998 withmore than 15 shareholders), Omtrix was able tobring in an additional full-time staffer. Eventually, thefund reduced full-time staff size as it began to exitinvestments.

Quickly, Omtrix recognized that the initial premise ofminimal investment engagement and relativelyhands-off management was impractical. Many ofthe fund’s initial investees were “NGO conversions”,MFIs that were moving from not-for-profit models toindependent financial institutions capable ofhandling equity investments. Over the fund’s firstthree years, these conversions required significantattention from the staff. In later years, the investeeprofile evolved such that many investments were in

“ProFund does not perceive a conflict between poverty alleviation andprofitability. In fact, it believes that financial viability is a necessity for thelong-term success of poverty alleviation efforts in microfinance.Accordingly, while most of ProFund’s shareholders are interested in thedevelopment of the microfinance industry, the fund seeks primarily toreceive an adequate return on its investments, which it considers themost efficient way to entice commercial capital into the sector.”49

newly created financial institutions, which alsocompelled highly engaged management. Whenmacroeconomic turmoil began to sweep LatinAmerica in the late 1990s, the staff found itselffurther stretched, making at least one deal thatsaved a healthy MFI from defaulting as a result oftemporary macroeconomic shocks.51 ACCION andother sponsors readily acknowledge that the staff’sextraordinary commitment and industry are largelyresponsible for the fund’s positive results. Theirexperience reveals that close engagement is criticalto such a fund’s success, and, of course, highengagement requires a commitment ofadministrative costs.

Given the risk associated with equity investments, asoundly diversified portfolio was indispensable toProFund’s success. The resulting portfolio achieveddiversification in countries, organizational forms(NGO-administered, existing financial institutions,and conversions from NGO to financial institution),market penetration and organizational maturity.52 Toprotect against undue investment concentration,the fund set a US$ 4 million cap on any singleinvestment. While the fund aimed to hold asubstantial equity position in each investee (at leastten percent of its outstanding shares), ProFundopted not to take controlling positions; a 20-30%target became the norm.

ProFund’s operations grappled with a profound,large-scale shift in the microfinance world, as thecentre of gravity for MFIs’ organizational formsshifted from NGOs to independent financialinstitutions. Not only did the fund develop expertisein effecting NGO conversions, it also learned tocreate near-equity investment structures incircumstances where the MFI could not acceptequity investments due to its corporate form, by-laws or regulatory environment. Cataloguing thespecific nature of those investment remains beyondthe scope of this paper, but the resultinginvestments typically resembled subordinated debtor preferred equity. In some cases, they involvedperiodic cash flows, and many such investmentvehicles included redemption clauses that providedinvestment exits on pre-arranged terms.

Once the fund finished liquidating its investmentsand distributing the proceeds to its shareholders,ProFund had realized a net IRR of 6.65%.

Key Lessons

Over the ten-year life of ProFund, its investors andstaff learned numerous lessons about managing amicrofinance equity fund. Silva explores many ofthose operations lessons in his essay, “Investing inMicrofinance: ProFund’s Story”, and readers areencouraged to refer to that document for a moredetailed exploration of those themes.53

In its survey of microfinance, “The Hidden Wealth ofthe Poor”, The Economist said of ProFund’s returns(before the fund had exited the last of itsinvestments):

At first sight, its returns look unexciting: just six percentannually, despite lots of risk. But on close examinationthis was a remarkable performance. All of ProFund’scapital was contributed in dollars and then invested inlocal currency. In every country it operated in, its dollarreturns were reduced by local currency depreciations,reflecting the economic chaos in Latin America duringthat decade. Two of the countries in which it hadinvestments, Paraguay and Ecuador, suffered system-wide financial collapse. Haiti, Venezuela and Bolivia facedriots and revolutions.54

In spite of significant currency losses, Silvaindicates that “in most cases . . . the subsequentoperational gains and intrinsic appreciation weremore than enough to offset currency related lossesand provide for the fund’s positive overall yield.”

Silva attributes the net gains to a number of criticalfactors. The first is the operational excellence of theinvestees’ own management as measured by theirability to lend to more customers and do so withincreasingly lower overhead costs. Silva has alsoacknowledged that ProFund’s early entry into thismarket place enabled it to “cherry pick” the bestinvestments at a lower investment cost, thanks toits lack of competition for deals. (Interestingly, Silvaobserves considerably more financing activity and,in turn, competition for deals in 2006. He hasstated that he would not run ProFund II in the samegeography because funding alternatives now exist,diminishing the likely success of a new fund—andfurther proving the success of ProFund as aninspiring demonstration of concept.) 55

Silva further identifies two other necessaryconditions for profitable microfinance equityinvesting: the MFI must be located in a country thatprovides a sufficient “enabling environment”, andthe MFI’s corporate governance must be soundand independent. In referring to the appropriateenvironment, he points to a country’s regulatory



and legal milieu. He cites an illustrative example:“[W]hen the Colombian government imposed tightinterest ceilings and thus prevented [ProFundinvestee] Finamerica from recuperating the highoperating costs associate with microfinance,”ProFund should have recognized the change in theinvestment environment and exited theinvestment.56 (Unfortunately, ProFund did not act intime, and the fund eventually realized a loss on thatinvestment.)

Successfully planning for exits at the time of theinvestments’ inception was another key successfactor. Silva notes: “No investment was approvedwithout some sort of negotiated exit possibility.”57

With liquidity events remaining an elusive goal formost private equity in developing markets,ProFund’s example presents a variety oftransferable operational lessons. The fund relied onseveral such exit strategies, many of which aresuitable for liquidating minority positions, which canbe especially difficult to sell when most buyers areseeking controlling interest.

• Put Options: These agreements gave ProFundthe right to sell shares in the investment to aparticular buyer, usually a larger co-investor, on aparticular date at a price determined by theinvestment’s performance. The options typicallyprovided a guaranteed exit opportunity of lastresort that did not necessarily ensure a profit.

• Controlling Block Shareholders’Agreements: Under such a contract, a numberof minority investors agree to coordinate in sellingtheir shares in unison so that a buyer can buy acontrolling stake by aggregating several smallershareholders’ stakes.

• Management buy-outs: ProFund alsonegotiated provisions by which an MFI’smanagement could purchase ProFund’s shares.Such arrangements may also involve sellerfinancing, in which ProFund would arrange forthe managers to borrow the funds that theywould in turn use to buy out the investors. Whilethis arrangement ensures that an interested partywill purchase the shares, it also introduces thepotential of moral hazard.58

• Redemption: When ProFund relied on quasi-equity structures, it typically included aredemption feature that would coincide withProFund’s closure and liquidation date.

Such provisions ensured that the fund would beable to liquidate investments, though the preferredexit remained selling the shares to a strategicbuyer. Potentially offering greater exit multiples,such buyers also include “local financial institutions. . . and international socially responsible investors(including the equity funds).” Nevertheless, “[p]rivateindividual or corporate sector buyers, while present,have not yet become a major force, and there issome reluctance to sell to such buyers unless theyare convincingly socially motivated.” 59

Interpreting the Results and Looking to the Future

Particularly considering the macroeconomicenvironment in which ProFund operated, its resultsare remarkable—and they are made even more sogiven the “experimental” nature of the fund.Nevertheless, Silva observes that a similar fund, iflaunched in 2005 in the same geography, would behard-pressed to replicate ProFund’s financialresults. Silva points to the “downscaling” of manymainstream banks that have moved tomicrofinance products and otherwise servepreviously un-banked poor people. He notes thatdownscaling may have a profound impact on howfinancial services are rendered to the poor.

He notes, “Coupled with lower cost of funds andunderutilized infrastructure, the commercial banksare clearly more professional and know financialintermediation better than [most] MFIs. In manycountries, downscaling is already as big as all MFIscombined.” Such developments help bring financialservices to more poor people by creating increasedcompetition for microentrepreneurial business. Thatincreased competition might cramp the returns ofMFI equity funds, but it might also introduce newexit opportunities for MFI equity investors asdownscaling banks choose between building andbuying microlending capabilities.

By 2005, a host of other microfinance equity fundswere investing with similar models (though all atearlier stages in the funds’ lives). They willeventually contribute their data to the discussion ofthe asset class, and their experience will helpestablish the extent to which ProFund’s financialreturns can be attributed to its being the first tomarket or to other factors, including the quality ofthe fund’s management and the overall nature ofthe investment strategy. These funds will alsocontribute to the body of best demonstratedpractices, which will help investors and managersunderstand how to replicate and eventually improveupon ProFund’s results.



Inescapably, ProFund’s experience throws foreignexchange risk into sharp relief. Even when oneinvests anticipating returns on par with mainstreamAmerican private equity portfolios (in the realm of30-40%), a major currency devaluation can quicklyeliminate hard-won investment returns. Of course,developing markets and international blended valueinvestors are quick to point out that foreignexchange rates can and do move in the otherdirection, and in many markets in the mid-2000s,they did just that. Nevertheless, the financial returnson investments in developing economies remainexceptionally sensitive to foreign exchange volatility,which as yet cannot satisfactorily be mitigated.Many well-informed would-be international blendedvalue investors have avoided such investments (inequity and in debt) largely due to the uncontrollableand vaguely predictable foreign exchange risk.When financial services entrepreneurs and financialinstitutions develop a mechanism that managessome foreign exchange risk at a reasonable cost, itwill likely open these investments to dramaticinflows of capital.

Concluding Thoughts

Equity investing in MFIs is a critical investmentstrategy, but it lacks single risk-reward profile.Equity investors, even more than debt investors,buy into the operations of the MFIs they support;the strong fundamentals of microlending alone willnot generate MFI equity returns unless the financialinstitution is well managed. With the equityinvestors even further behind debt holders in theirclaim on an MFI’s free cash flows, an equityinvestor must be that much more certain thatsufficient cash flows will accumulate. Theextraordinary range of corporate forms, lendingmodels, and management strategies employed byMFIs makes equity investing a complex proposition.For example, the risk profile of an MFI convertingfrom NGO to independent financial institution willdiffer significantly from an established financialinstitution that is extending its conventional modelsto new markets. Accordingly, perceptive, astutefund managers with deep microfinance and capitalmarkets experience are absolutely essential to thesuccess of equity funds.

ProFund has proven unambiguously that one cancreate social and financial value by investing in MFIequity, but investors have a long way to go beforetruly understanding the risk-reward profile of someof these investments. Fortunately, other blendedvalue investors have engaged in this investmentstrategy and in due time will help reveal its nature.

Second Case Study: Aavishkaar India MicroVenture Capital Fund 60

Founding Aavishkaar

Aavishkaar founder and CEO Vineet Rai discoveredthe need for micro-scale equity investments as theCEO of the Grassroots Innovation AugmentationNetwork (GIAN), an incubator for rural ventures inIndia. The entrepreneurs working with GIAN werecaught between established financing mechanisms.Microfinance was not appropriate for theseinventors; many had grown too large for microloans.Furthermore, these entrepreneurs were oftencreative inventors who had developed novel ways ofaddressing problems. Their inventions still requiredinvestment before they would generate predictablecash flows; accordingly, they were simply not suitedto debt financing.

Rai’s entrepreneurs faced financial institutions thatwere not equipped to help them grow. Many bankssimply did not have programmes for working withsmall enterprises, especially those that weredispersed throughout rural areas. While India has avital and growing venture capital market, most VCsare located in the cities (to be close to the clustersof innovation), and they operate almost exclusively ata scale that is an order of magnitude larger thanGIAN’s entrepreneurs. Rural India simply does notoffer an angel network that could finance theseenterprises.

Thus, Rai’s entrepreneurs faced a grave funding gapbetween microfinance investment products (usuallywell below US$ 1,000) and established venturecapital fund investments (typically beyond US$1,000,000). The rural entrepreneurs being incubatedby GIAN needed flexible equity financing, patientcapital that would help them build their enterprises’capacity and open further opportunities for growth.

After meeting with Indians living in Singapore, whothemselves were contemplating more sustainableways of supporting their motherland, Rai and hisassociates conceived of a new financing entity toaddress that gap, and Aavishkaar India MicroVenture Capital was born. In Hindi, Aavishkaarmeans innovation, and it invests in innovative ruralenterprises that are “socially relevant,environmentally friendly, and commercially viable.” 61

Like traditional venture capital, Aavishkaar focuseson innovations that have the potential to benefit fromeconomies of scale. Unlike the typical venture capitalmodel, Aavishkaar invests only in small enterprisesthat could make a difference in the lives of ruralIndians.



Managing Regulatory Constraints

Beginning in 2002, Aavishkaar approached India’sSecurities and Exchange Board (SEBI) with theintention of formally incorporating as a venturecapital fund. Formal incorporation posed a numberof obstacles, including a minimum fund size thatexceeded Aavishkaar’s initial capacity to invest. Theminimum fund size delayed Aavishkaar’s initialventure investments while it worked to build asufficiently large fund. The founders opened aSingaporean sister company, AavishkaarInternational, to pool overseas investors’ capital forinvestment in Aavishkaar as a single entity, anarrangement prompted by SEBI’s regulations. Thefund ultimately met its regulatory requirements andformally incorporated in May 2002.

Dr V. Anantha Nageswaran, a member ofAavishkaar’s management board, indicates thatIndian regulations do not encourage the flow ofcapital into non-traditional VC investments. Henotes: “If banks could be allowed to contribute to .. . non-traditional venture capital funds, and if suchcontributions counted toward their obligations tothe priority sector, then the flow of funds to thenon-traditional venture capital industry wouldincrease.” 62 Furthermore, some flexibility in the sizeand structure of the regulated venture fund wouldencourage further growth.

Fund and Deal Profile

Aavishkaar’s investors are mostly individuals, andthey have committed an average of about US$16,000 to the fund. In late 2005, the fund totalledabout US$ 1.3 million, and it had placed sixinvestments, with several others nearingcompletion.

Investments are scaled appropriately to the targetcompanies that Aavishkaar aims to support, andthe deals range in size from US$ 10,000 to US$100,000 with the average being about US$ 30,000.Aavishkaar seeks an ownership stake ofapproximately 26%. While the investments aresmaller than those of a typical VC, Aavishkaartargets VC-level returns for each investment, aimingfor a 32% internal rate of return (IRR). Nevertheless,Rai anticipates a rate of enterprise failure that willlikely exceed the typical VC’s rate, and heanticipates the overall fund’s IRR ultimately to be inthe range of 5 to 10%.

He anticipates the duration of a typical investmentwill be as long as seven to nine years, which isconsiderably longer than the typical holding periodof a standard VC. Accordingly, the fund has not yet

exited a deal. Nevertheless, those exits are likelyultimately to come in the form of a share buyback(in which the entrepreneur repurchases shares inhis or her own company either with accumulatedearnings or with commercially available debt),merger or sale of the enterprise, but Rai does notrule out the possibility that one of these enterpriseswill ultimately be sold on the public markets.

Investment Example

One of Aavishkaar’s first investments was in ShriKamdenu Electronics Private Ltd (SKEPL) in April2003. The fund invested about US$ 36,000 for a26% stake in the company, which developsappropriate technology for dairy cooperatives.SKEPL’s product portfolio includes automated milkcollection and analysis systems that are suitable foruse in India’s tens of thousands of milkcooperatives. The product has the potential tomake milk production safer and more efficient,thereby potentially improving the lots of the millionsof milk co-op members.

Lessons Learned (or Lessons Learning)

Rai and everyone associated with Aavishkaar treattheir fund as a carefully executed, high-stakesexperiment. With a risk tolerance suitable to SiliconValley, Rai declares that even if Aavishkaar fails, itwill have been a success in that it will advance thestate of the discourse about financing innovativerural entrepreneurs. He is confident that a privateequity market will eventually grow up around theseentrepreneurs, and Aavishkaar’s approach mayhasten the day it arrives. Nevertheless, heacknowledges that the market is miniscule, and afailure now could hobble the asset class for a longtime.

In its several years of operation, Aavishkaar hasseen its deal flow improve gradually butcontinuously, and the investment pipeline is nowbetter suited to the size of the fund than it was inthe early days. As Aavishkaar establishes areputation, it sees more potential deals, includingmany that fall out of its focus area. Fund managersmust resist the temptation to make largerinvestments that do not strictly fit the fund’sinvestment focus. The temptation to move towardlarger deals is great, as larger deals are, from afinancial perspective, more efficient ways ofdeploying capital. Rai ultimately observes thatAavishkaar’s small investment scale will limit itsprofitability, and it is difficult to imagine that thereturns can be sufficiently large to overcome thecosts associated with supporting the investments(e.g.: due diligence, investment monitoring and



technical assistance). Without substantial returns,Rai raises concerns about retaining his capable andpassionate staff. He needs employees withsubstantial professional financial experience andthe opportunity costs for such professionals can bequite high.

In spite of these challenges, Aavishkaar haslaunched a viable fund in an investment space thathas not yet had the benefit of competitors who canaddress the same challenges that Rai faces. Theprospect of competition is very appealing to Rai, asother funds will help wring out inefficiencies, attractmore capital to the sector, and ultimately make itmore viable for rural entrepreneurs to take risks forthe sake of building value. Though Aavishkaar stillhas no direct competitors, the fund has attractedthe attention of other investors who are consideringsimilar investment strategies, with one similar fundapparently close to launching.

Third Case Study: ShoreCap Internationaland ShoreCap Exchange63

ShoreCap International (SCI) is a private equity fundinvesting in MFIs and banking institutions thatfinance small- and medium-sized enterprises(SMEs) in Africa, Asia and Eastern Europe. SCI isnot the only private equity fund investing in suchinstitutions. This document refers to other MFIequity investors, but there is an increasing numberof funds investing primarily in financial institutionsserving SMEs in emerging economies. The BalkanFinancial Sector Equity Fund (managed byDevelopment Finance Equity Partners) would serveas one of several examples.

SCI adopts active roles in the companies in which itinvests. Its work is corroborated and advanced byShoreCap Exchange (SCE), an American not-for-profit organization that provides technicalassistance to banks in SCI’s portfolio and to othersimilar institutions. Both SCI and SCE were spunout of ShoreBank Corporation in the US, and theirwork draws considerably on ShoreBank’s path-breaking and market-leading communitydevelopment banking model in the US.

ShoreBank Corporation

ShoreBank began operating in Chicago, Illinois,USA in 1973, practicing what is now commonlycalled community development banking. The bankhas become a diversified, full-service institutionoffering financial products and services designed to

enhance economic development in underservedAmerican communities. The bank expandedoutside of Chicago in 1986, and now it haslocations in communities across the United States(including Detroit, Cleveland, Michigan’s UpperPeninsula, Portland, Oregon, and Costal Oregonand Washington). ShoreBank Advisory Servicesextends the bank’s work to other financialinstitutions outside of the ShoreBank network. In1994, the bank entered the field of environmentalbanking, bringing its investment practices to bearon conservation and environmental improvement.

The bank now manages over US$ 1.7 billion inassets committed to community development, andits net income exceeds US$ 7 million per year. JanPiercy, a ShoreBank Executive Vice-President andformer US Executive Director of the World Bank,notes that ShoreBank’s original bank in Chicagonow outperforms many of its peer banks that donot have a community development investmentfocus.

The bank began working internationally in 1983with the Grameen Bank in Bangladesh. And in the1990s, its work expanded to Poland, Pakistan, theformer Soviet Union and elsewhere.

Introduction to ShoreCap International

Funding SCI

SCI was launched in July 2003 with US$ 28.3million in committed capital from 14 differentinstitutions. The fund is structured as something ofa hybrid between a permanent investmentcorporation and a limited-life investment fund. Ithas a mandate to invest funds for five years,concluding its investment activity in 2008. SCI doesnot have a terminal date or a requirement toliquidate its holdings by a particular deadline. Until2008, the fund’s directors can determine whetherto re-invest any realized gains or to distribute themto investors. After 2008, investors themselves candetermine whether they would like to have thosegains paid out or reinvested. The fund managersaim to invest US$ 23 million of the fund, reservingseveral million dollars to make follow-oninvestments and to support the fund’s expenses(with very little current income, the fund must relylargely on its committed capital to fund expenses).SCI expects a seven percent IRR for the fund itself,which is concessionary to the risk-adjusted marketrate.



Investors

The fund’s 14 investors committed an average ofUS$ 2 million to SCI, and their investments rangefrom US$ 250,000 to US$ 4 million. They includedevelopment finance institutions, sociallyresponsible investment funds, foundations and oneglobal commercial bank, ABN AMRO. TheNetherlands-based bank’s American subsidiaryLaSalle Bank had worked with ShoreBank to meetits community investment obligations under theCommunity Reinvestment Act. Spurred in part bythe investments made with ShoreBank’sassistance, the LaSalle and ABN AMRO executivesrecognized that community development clientswould be their future mainstream clients.Accordingly, ABN AMRO invested in SCI to learnmore about its future mainstream clients inemerging economies.

Investment Parameters

SCI invests in financial institutions that providefinancing and banking services tomicroentrepreneurs and small businesses thatcreate economic opportunities for poor people. Thefund invests in regulated banks, MFIs, and otherfinancial institutions as long as at least 50% of theinstitution’s assets are dedicated to financing small-and micro-sized enterprises that employ low-income people. Typically, it invests US$ 500,000 toUS$ 2.5 million in equity with some convertible orsubordinated debt, and its investments are made inlocal currencies. SCI’s hurdle returns on equity are12%, and it anticipates an average holding periodof five to seven years. Though SCI does not takemajority stakes in any of its investments, it doestake board seats, often placing a top ShoreBankexecutive on the bank’s board. The fund currentlyoperates in Africa, Asia and non-EU EasternEuropean countries.

Deal Flow

Paul Christensen, president and COO of ShoreCapManagement, the fund manager, indicates that it ismuch easier to identify microfinance deals, giventhe prominence of the sector and the fact thatthere are other investors seeking similar deals.Identifying investment prospects is morecomplicated for institutions that finance SMEs.ShoreBank’s Advisory Services often sources suchdeals, and occasionally, existing SCI investmentsrefer other potential investments. In some cases,

Christensen and his team prospect by travellingthroughout Asia, Africa and Eastern Europe seekingfinancial institutions that might be investmentprospects. SCI lists investment pipelineopportunities in Ghana, Uganda, Afghanistan andAzerbaijan, among other countries.

Measurement and Monitoring

SCI expected to have made eight investments BYlate 2005, totalling US$ 9.5 million, with severalother likely investments pending. Through itsregular monitoring and involvement of SCE, SCIremains in close contact with the banks in which itinvests. Not only does it track the financialperformance of its investments, SCI also works toassess its investments’ social impacts. Christensenreports that tracking impact outputs for MFIinvestments is easier than doing so for SME-oriented investments. Some of SCI’s MFIinvestments are already assessed by MFI ratingorganizations that track metrics like number andsize of new loans and the gender mix of borrowers.In measuring the fund’s SME investment impact,SCI has deployed many of the tools thatcommunity development banks use in the US. Theyattempt to measure the number of smallbusinesses associated with the banks, along withthe total number and quality of new jobs created.Nevertheless, the dispersed nature of theinvestments and the cost of measuring both makeit difficult to compile accurate and complete data.

Introduction to ShoreCap Exchange

SCE is an independent American not-for-profitorganization that operates internationally and isfunded primarily by grants. SCE supports many ofSCI’s investments by offering technical assistancein the areas of organizational capacity-building,best practices transfer and “banker-to-banker peerexchange.” While donors support SCE’s work,client banks must make co-payments (determinedon a sliding scale) for the services, ensuring thatthey are fully invested in the capacity building andknowledge transfer that SCE facilitates. SCE alsosponsors a variety of exchange programmes thatencourage knowledge transfer between bankers indeveloped economies with their colleaguesoperating in developing economies. SCE’sinvolvement not only encourages positivedevelopment outcomes, but it helps to lower therisks associated with SCI’s investments.



SCI Looks to the Future

Nearly halfway through the investment process atthe end of 2005, Christensen suggests thatShoreCap’s future international private investmentfunds will likely have a sharper geographic focus.He notes that it can be a challenge to cover Africa,Asia and Eastern Europe with a staff appropriate fora US$ 28 million fund. Beyond regionalspecialization, Christensen sees opportunities toexpand this investment model to the low-incomehousing sectors of developing economies. He seesboth viable potential business models and theopportunity to finance a substantial developmentimpact, and he predicts that more capital will flowinto low-cost housing finance in the next severalyears.

Fourth Case Study: Actis 64

Whereas Aavishkaar and ShoreCap were bothfounded as unorthodox approaches to privateequity investment specifically intended to createblended value, Actis is a mainstream private equityfund with over US$ 3 billion under managementand generating market-rate financial returns. With ahistory stretching back to 1948, Actis’s ingrainedorganizational values and investment strategieshave driven the firm to generate multiple returnsbefore it ever articulated a blended valueinvestment strategy.

Actis’s History and Investment Focus

Until its management buyout in 2004, Actis was apart of CDC Group PLC (formerly CommonwealthDevelopment Corporation), which was whollyowned by the UK government. As the UnitedKingdom left its former colonies in the 1940s, itformed the CDC to begin establishing privatesectors in the nations it departed. Initial investmentvehicles were debt instruments with some privateequity investments, but over 50 years the fundchanged the balance of investments so that by2005 its assets were almost exclusively privateequity (consistent with a standard private equityfund’s allocation).

Ultimately, CDC’s management and the UKgovernment pursued a privatization plan that wouldallow existing management and employees to buyout 60% of the company, thus converting it into aconventionally organized private equity fund. Themanagement completed the buyout in 2004, whenthe management company was renamed Actis.

While the government still owns 40% of themanagement company, Actis now raisesinvestment funds in accordance with typical privateequity practice.

Actis has 16 offices, most of them located in thedeveloping economies where the fund invests,including five offices in Africa, four in Central andSouth Asia and one in China. Staffed by over 90investment professionals, the firm has developed adeep understanding of the markets in which itoperates. Being geographically close to theirmarkets, Actis’s investment professionals maintainclose engagement with their investments.

The deal sizes typically range from US$ 10 millionto US$ 50 million, and the fund invests only inhealthy, established enterprises with high growthpotential. It selects sectors on a local basis,enabling it to choose those that offer the bestpotential for growth and benefit for the localeconomy, while avoiding those where corruption,environmental liabilities or other potential hazardsmake investments unappealing.

Between 2004 and 2005, Actis raised six regionalfunds and an umbrella fund investing in theregionally defined funds. If Actis meets its targetfund sizes, the new pools of capital will representover US$ 450 million directed to investments inAfrica, US$ 225 million to China, US$ 325 million toIndia, and US$ 225 dedicated to South andSoutheast Asia. Since 1998, it has exited over 50%of its South Asian investments, generating a grossIRR of 34%. In the same time period, it exitednearly half of its investments in Africa with a grossIRR of 23%. Though it has exited only two of eightinvestments in China, the realized gross IRR forthat portfolio has been 54%.

Generating Multiple Returns

Actis’s engagement in generating multiple returnsbegins at the investment screen, as it avoidscompanies that have poor reputations, will beplaced at competitive disadvantage by upholdinghonest business practices, or will be potentiallyresistant to Actis’s responsible engagement. Withinthe company, Actis aims to improve corporategovernance, health and safety standards and/orenvironmental practices. In some of the changes itadvocates, Actis resembles a progressive activistshareholder. It does so because such practices areingrained in the firm’s values and because theyincrease financial value.



When it has the opportunity, Actis advocates forregulatory and legislative changes that willencourage a healthy, competitive and responsibleprivate sector. The benefits of such advocacyaccrue to Actis in that its investments can pursuetheir businesses with less friction. Furthermore,Actis-supported enterprises are prepared tocompete successfully in competitive businesssectors, and the fund is betting that its venturescan win on a level playing field. Naturally, thebenefits of such work accrue to the communitiesand countries where Actis-supported venturesoperate.

Social Fusion mapped Actis’s approach intoframeworks presented in “Developing Value: TheBusiness Case for Sustainability in EmergingMarkets”, a white paper published by the IFC,Ethos Institute, and SustainAbility 65, 66 The“Developing Value” framework explains how“environmental risk reduction” and “socio-economicrisk reduction” can be practiced such that theyengender improved economic returns forshareholders as well as benefit other stakeholders.(See figure 7 for a concise representation of thatframework.) The authors of the “Developing Value”study map a series of risk-reducing actions thatgenerate medium- and long-term business results.The framework then establishes how these resultsconfer benefits or returns on multiple stakeholders,including employees, investors and the community.

Social Fusion discovered that Actis’s investmentsconsistently fit this framework. The firm’sinvestment professionals recognize the significantrisks inherent in investing in emerging markets, andtheir systematic, thoughtful approach to mitigatingthose challenges translates into concrete actionsthat also create environmental and social value.

Improving Exit Multiples

Managing Partner Jonathan Bond observes thatActis regularly sells portfolio companies to largeEuropean and global firms, many of whichrecognize the risk engendered by environmental,social, and corporate-governance-related liabilities.Many companies will not even consider acquisitionsthat do not meet or approach their own standardsfor social and environmental practices. Accordingly,Actis aims to build companies that will appeal tosuch acquirers, and doing so engenders benefitsfor the portfolio companies’ employees,communities and economies.

Investment Example: Celtel

Bond reports that the firm sees a tremendousappetite for capital in Africa, where one of thehighest-growth industries is wirelesstelecommunications. The growth rate in wirelessservices in Africa exceeds that of any other regionin the world. Actis entered the sector with a



Figure 7: The Developing Value Framework

Source: Social Fusion and Actis, adapted from “Developing Value: The Business Case for Sustainability in Emerging Markets"

significant investment in Celtel, a pan-Africanwireless service provider, shortly after Celtel’sfounding in 1998. By the time of the company’ssale in March 2005, Actis had invested a total ofUS$ 77 million, representing 9.3% of thecompany’s shares. Kuwaiti wireless concern MTCpurchased Celtel for US$ 3.4 billion, giving Actis a77% gross IRR. Of the US$ 3.4 billion purchaseprice, Bond reports that some US$ 2 billionrepresented goodwill, value the acquirers ascribedto knowing that Celtel’s contracts were alldependable, that the company had alwaysoperated to the highest ethical standards, and thatit would not discover any fraud or hidden liabilities.

While it owned Celtel, Actis had many opportunitiesto advocate for multiple returns. The firm workedwith government officials in the African countrieswhere the company operated (particularly in thosewhere it was among the largest taxpayers) toensure that taxation and other business regulationswere transparent and uniformly practiced. Celtelalso instituted strong employee-developmentprogrammes and strict environmental protections.Furthermore, Celtel is active in many of thecommunities it serves, sponsoring varioushealthcare, education and other communityinitiatives.

Opportunities

In potential financial returns, Actis sees tremendousopportunities for investing in emerging markets.Especially in Africa, the firm is not wanting forinvestment opportunities. While the risks remainsignificant, the firm and other experienced privateequity investors with personnel in-country are wellpositioned to reduce that risk, often in ways thatengender positive returns in other dimensions ofvalue.

Gillian Arthur is the head of Actis’s OperationsGroup, which ensures that the firm’s approach tohealth and safety, social and environmental issuesis integrated throughout the investment lifecycle.She notes that Actis’s most significant andimmediate impact may be in the realm of employeehealth and safety, and Actis pushes its portfoliocompanies constantly to improve workingconditions and opportunities for their employees.Actis will have ample opportunity to make suchimprovements as it invests recently raised funds incountries that have poor reputations forsafeguarding employee health and safety.

Interest in blended value investing is buildingmomentum. More and more capital is being guidednot just by a conscience but by a proactive,sophisticated set of ethics. With the assistance ofSocial Fusion, Actis is currently exploring howinvestments in Actis can play a role in blendedvalue investment strategies. To that end, SocialFusion has convened a series of “investorroundtable” events that have brought Actis partnerstogether with potential blended investors in order toexchange ideas and discuss opportunities.67 Itshould be noted clearly that Actis does notpromote itself as a “socially responsible” investmentmanager, per se. Instead, it is transparentlypresenting its goals and practices to investors whocan then determine how or whether an investmentin Actis has a role in their portfolios.68

In conclusion, as this modest slice of thedeveloping private equity market universedemonstrates, private equity investment can bevery flexible and can adapt to the variety ofopportunities arising in developing economies.Making private investment work for internationalblended value creation will require additional time tobuild upon this initial track record to increase theexperience of those structuring these funds andexpand the capacity of both funds and supportingintermediaries working in this area of capitalallocation. There are promising developments, suchas the launch of VantagePoint,69 a non-profitworking regionally with investors to help expandventure capital options in emerging markets andthe ongoing work of Endeavor,70 providing supportto entrepreneurs in emerging markets, both ofwhich reflect the growing interest in and promisingdevelopments of venture capital expanding intothese emerging markets.




Thus far, this paper has focused on the variety ofpotentially scalable investment instruments andcapital structures one could deploy to generatemultiple returns. Each example demonstrates theconvergence of creative financial engineering andthe desire to expand access to capital fororganizations creating blended value. Such capitalinnovation seems sure to continue and evenaccelerate, but the investment vehicles are onlypart of the story.

In its pure sense, all investing activity has within itblended value components of social, environmentaland economic value. What is striking to note,however is that at the present time, as potentialinvestments mature and proliferate, investors areincreasingly combining them into carefully tunedportfolios strategically positioned to generatesophisticated and specific blended value returns.Several such portfolios already exist. They maydiffer from one another significantly, but they allhave in common a concerted and well-consideredaim of maximizing value in multiple dimensions.

The next several pages suggest future investigationspurred by the preceding inquiry into investmentvehicles. We briefly explore the opportunities andchallenges for investors who would build a“blended value investment portfolio theory” intotheir investment strategies. An introduction to twonotable examples suggests areas for future study,including an inquiry into how these investors haveapproached their work, defined opportunities andaddressed challenges.

Rethinking Portfolio Theory

Traditional portfolio managers map theirinvestments to a two-dimensional efficient frontierthat balances risk and financial reward. Themanagers of BVI portfolios tend to view value inmultiple dimensions, which in turn requiressignificant changes to standard portfolio theory andmanagement. These managers must begin byaddressing the challenge of translating theirinvestors’ conception of value into an investmentthesis, a detailed explanation of what the investorbelieves to be true about blended value and thehigh-level strategies that will responsibly maximizevalue within that framework. Creating a durable andversatile thesis is made particularly complicated bythe pace of change in blended value investors’sophistication and, as this paper has documented,the pace of the investment products’ evolution.

Investment portfolios that aim to maximize blendedvalue must project a desired integration of financialand other dimensions of returns. Then they mustalso develop guidelines for many other investmentand portfolio variables, some of which areinterdependent. Such investors must address anumber of questions:

• Types of investment: Will the portfolio invest indebt, equity, and/or other types of securities? Willcapital support for-profit and/or not-for-profitinvestments?

• Level of engagement: To what extent will theinvestor and portfolio manager engage theinvestments? Will they approach investment withthe hands-on perspective of a venture capitalinvestor, or will they adopt a more passiveapproach to investees’ management?

• Investment concentration and targetallocations: How much of the portfolio shouldbe allocated to relevant segments of blendedvalue investments and how concentrated in anyone specific investment will the portfolio be?

• Investment in research and development: Inaddition to deploying capital to blended valueinvestments, to what extent will the fund invest inadvancing the field through research anddevelopment around its BVI strategies?

• Performance measurement: How will theportfolio measure the value it creates and theoutcomes it engenders? How can thesemeasurements be used to adjust the portfoliodynamically?

The F.B. Heron Foundation, based in New York,has explored many of these questions in the courseof its work to restructure its assets along the linesof a unified investment strategy. Theirdocumentation of how they have executed thisinstitutional transformation is very informative andavailable on their website.71

Blended Value Portfolio Examples

While all capital has the potential to generateblended returns and many investors haveintegrated some element of blended value investingprinciples into their practices, two funds stand outas having been constructed and managed tomaximize blended value through the application ofinnovative investing strategies.

Building Blended Value Portfolios


Acumen Fund

Formed in 2001 with grants from the RockefellerFoundation, the Cisco Systems Foundation, andindividual investors in Silicon Valley, the not-for-profit Acumen Fund invests in market-basedsolutions to problems associated with globalpoverty. Acumen CEO Jacqueline Novogratz statesthat Acumen is “agnostic” about whether it fundsfor-profit or not-for-profit enterprises, but in recentyears it has moved away from grant-making as itdiscovered the unmet need for financing market-oriented solutions. Accordingly, the bulk of itsinvestments take the form of debt and equityvehicles. While Acumen invests for blended returns,anticipating a concessionary rate of financial returnon invested capital, its investors make charitablecontributions and do not expect to capture financialreturns. To date, the organization has madeinvestments in India, Pakistan, Egypt, South Africa,Tanzania and Kenya.

Two hallmarks of Acumen Fund’s approach are itsventure-capital style engagement and a portfolioapproach to BVI. The organization currently hasthree investment portfolios, each with a specificapproach to creating blended value: heathtechnologies (investing in technologies andassociated business systems that increase qualityand access to healthcare), housing and finance(making investments in infrastructure and financingsystems to make home ownership moreaccessible), and water innovations (improving thequality and availability of fresh water supplies byinvesting in purification, distribution andconservation solutions). A portfolio managersupervises the investments in each area, and he orshe works closely with an advisory committeecomprised of domain experts. Novogratz notes thatthe portfolio approach helps diversify risks andcreate “strategic networks to facilitate the overallwork of investment.”72

Each portfolio manager works with only a handfulof investments at any given time. Accordingly,Acumen Fund can maintain close engagement withinvestees, which facilitates investment monitoring,strategic consultation and network building.Portfolio managers and the entire staff deploy aperformance measurement system originallydesigned in consultation with McKinsey andCompany. The organization notes, “[o]ur metricsfocus has grown to become an integrated part ofeverything we do, both externally and internally.”73

On a regular basis the organization measures itsprogress with financial metrics, social outcomesand improvements in its investments’ internalcapacity.

Acumen notes that over one million people havebenefited from the fund’s investments. Amongthose whose lives have been improved, theorganization cites the following statistics: “morethan 500,000 people have been protected frommalaria, 12,000 women have received microfinanceloans, 5,000 farmers have increased their incomeby purchasing drip irrigation systems, and 11,000families have bought life-saving de-fluoridationwater filters.”74

The following diagram (figure 8), available onAcumen Fund’s website, maps the evolution of theorganization’s investment thesis as it moved fromgrant-making to blended value investing withsignificant expected financial returns. Furthermore,the diagram concisely presents Acumen’sassessment of its social impact.

ProVenEx: Rockefeller Foundation’s DiversifiedBlended Value Portfolio

Formed in 1998, Program Venture Experiment(known widely as ProVenEx) is the RockefellerFoundation’s experimental blended value portfoliocreated, in part, to explore how the foundationmight advance its mission through investmentvehicles other than grants. ProVenEx also exploreshow to scale up blended value investments while“building in accountability for social outcomes.”75 AllProVenEx investments create value within thefund’s areas of interest.


Acumen Fund’s MissionAcumen Fund is a global non-profit venture fundserving the four billion people living on less than US$ 4a day. Our aim is to create a blueprint for buildingfinancially sustainable and scalable organizations thatdeliver affordable, critical goods and services thatelevate the lives of the poor. We adhere to a disciplinedprocess in selecting and managing our philanthropicinvestments as well as in measuring the end results.

Source: Acumen Fund, http://www.acumenfund.org/About/


ProVenEx’s US$ 13 million portfolio has beendeployed in 12 investments spanning a range ofinvestment vehicles, including equity, debt and loanguarantees, and investments are made directly orthrough financial intermediaries when appropriate.Two of the twelve investments have beeninternational, representing five percent of theinvested capital. Specific notable investmentsinclude early-stage investments in Ugandan andKenyan companies, investments in communitydevelopment venture capital, a real estatedevelopment serving low-income neighbourhoodsin San Diego, California, and a loan and guaranteeto scale up Calvert Foundation’s CommunityInvestment Note programme. Among its outcomes,

ProVenEx counts a liquidity event from its largestinvestment, significant loan repayments, theemployment of over 1,600 people and improvedseed supplies sold to 25,000 small farmers.

Funds such as Acumen and ProVenEx may notultimately replace existing investor options, but theyprovide excellent examples of how investors candraw on the other tools and approaches outlined inthis paper, combining them with one another andwith other investment options to create value inmultiple dimensions. Ongoing research will helpexplore how these and other investors are applyingfinancing approaches to BVI—and the returnsgenerated by such strategies.


Figure 8: Acumen Fund’s Learning Curve

Source: Acumen Fund

ProVenEx Areas of Interest• Creativity and Culture

- Mechanisms to support creativity and open communication across diverse cultures• Food Security: Focus on small farmers in sub-Saharan Africa

- Ecologically sound strategies to increase stability of crop yields- Business investments to promote local industry for fertilizers, seeds and ancillary agricultural services (storage, grain

handling, processing, etc.)• Health Equity

- Products and health services delivery models to address major diseases affecting poor people, including HIV, TB andmalaria

• Working Communities: Focus on US inner-cities- Community-directed businesses that create jobs for local residents- Strategies to redress the imbalance of public funding to low-income school districts- Innovative mixed-income housing projects in US inner-city neighbourhoods

Source: Jackie Khor, ProVenEx Associate Director. “Background Information” presentation dated May 2005.


Of Opportunity and Risk

This paper has documented just some of theimproving prospects for applying mainstreaminvesting practices toward achieving social andenvironmental goals. Strategies such asmicrofinance and social enterprise, initially havingbeen launched primarily with philanthropic support,are now approaching the status of “mainstream”investment opportunities for banks, foundationsand high net worth individuals interested in doingwell while doing good. For those who believe in thepower of market forces and free enterprise—aswell as the need to create a more just world—theseare exciting times.

These transitions from philanthropic capital tofinancial investment capital are particularly unusualand even anomalous events in the history of capitalmarkets. While investors may analyze and learnfrom the “non-profit to for-profit” transformation ofhospitals as well as specific financing innovationssuch as the affordable housing tax credit, there arevirtually no historical examples of wide-scaleeconomic initiatives that began on a philanthropic(wealth transferring) platform and segued to a risk-oriented (wealth creating) platform capable ofattracting private capital. In this nearlyunprecedented situation, one must carefully re-evaluate the usual rules for gauging risk and returnas they apply to this major capital marketstransformation.

In the context of a blended value capital market,there is real risk and there is real return. However,to an outsider trying to determine whether or not toinvest in or contribute to a microfinance entity or afor-profit social enterprise, the investment decisionis quite simply not as straightforward as it would befor investors considering traditional investmentopportunities. This complexity arises from capitalmarkets that heretofore did not reflect the truenature of value; instead, they artificially broke valueinto components that over simplified the goals ofcreating value. Those capital marketscorresponded to two very different sectors (onenon-profit and the other for profit) that, of course,still exist today. Each has its own rules, regulationsand relevant approaches to analysis. Nevertheless,value is a more complicated construct, andmaximizing it with consistency will require thatinvestors revise their rules for investing capital. Theymust be careful to combine the best aspects ofphilanthropic and financial investing, and they mustbe especially wary of combining the strategies inways that obscure risks and jeopardize overall,long-term blended value creation.

Developments in financial instruments, portfoliotheory, creative market-based problem solving, andtheir underlying conceptions of value are veryencouraging. They should be supported, expandedand celebrated as being revolutions in thought andpractice that create real value. At the same time, itis critical to reflect on the risks present in anyemerging market and to define what mechanismsshould be in place to minimize those risks. Ifefficient markets capable of attracting significantcapital to blended value investments are ever goingto emerge, would-be market participants mustobserve and address the characteristics thatcurrently prevent the nascent blended value capitalmarkets from functioning as efficiently as moreestablished, efficient capital markets.

Many of the extraordinary projects documented inthis paper—and so many other innovations notaddressed herein—are, quite simply, in jeopardy. Atthis stage of development, blended value investingstrategies are poised either to become victims oftheir own success or—with careful guidance—toemerge victorious as new waves of capital areprudently deployed in blended value investments.Should significant new blended value investmentsturn out to be founded on poor due diligence orfaulty risk-management, those mistakes could sourthe market for years to come. The collapse of anyof the initial funds and investment instrumentscurrently capitalizing the next stage of blendedvalue investing would not only spell the end of thatparticular offering; it would make it extremelydifficult for future offerings to find investors. TheChinese character for “change” is a combination ofthose for “risk” and “opportunity”, and such is thechange in process.

Early financial failures would deal a significant setback to all those around the world who areattempting to bring new investment strategies toother emerging areas of economic development.Funds targeting small- and medium-sizedenterprises in emerging economies, newly seededrenewable energy funds, community developmentventure capital funds, and many others havereason to be concerned and to ensure that earlyinvestment decisions are made wisely. This concernis not to say that mistakes cannot or should not bemade. If the risk associated with these deals isappropriately priced and the markets are indeedefficient, some investors will lose money. Thesemarkets do not need to ensure that investors neverlose money (doing so would distort the market inways that would ultimately hurt value creation).Instead, the emerging market participants mustensure that every deal either succeeds or, in the

A Cautionary Conclusion: Maximizing BlendedValue Returns by Embracing Market Fundamentals


words of Tom Peters, “fails forward”. Participantsdo not need to prevent all losses of money, butthey must avert the catastrophic failure that arisesfrom incompetence, hubris or malfeasance.

Looking to the Future of a Blended ValueCapital Market

For years the focus of a great deal of work hasbeen upon the challenge of how to build themicrofinance capital market—and many haveworked to address that challenge. At the sametime, another, broader question remains:

How do we create investment strategies that are bankableand socially valuable, capable of providing capital tomicrofinance, social enterprise, small- to medium-sizedenterprises, community development finance and more?

Microfinance and other blended value creationsystems share challenges in gaining access tomainstream capital flows, though eachprogrammatic area stands in a unique position—itsown particular distance from that ultimate goal.Nevertheless, a series of approaches, principlesand concrete steps will help participants respond tothe common challenges shared by everyoneinterested in applying financial investment strategiesfor social and environmental gain.

Defining the “Push” Investing Past and the “Pull”Investing Future

Several decades ago, the hundreds of millions ofdollars initially needed to launch and growmicrofinance were provided with little or noexpectation of financial return to the initial investors.One might characterize this investment as a “pushstrategy,” driven by the suppliers of capital:• It was pushed by donors, philanthropic

organizations (foundations) and governmentalorganizations, which in turn created the MFIs todeploy the funds.

• They pushed capital into microcredit because ofits remarkable ability to create sustainablemicroenterprises started and owned by the poor.

• Philanthropic investors pushed it with little initialregard for whether the capital would be returnedand, in many cases, limited understanding ofwhether it had been well deployed.

And it has been a successful strategy!

These early individual and institutional philanthropicinvestments demonstrated that poor people indeveloping countries could “help themselves” in asustainable manner. These early philanthropic“investors” played the role of risk-tolerant angelinvestors as they helped capitalize a new industry.Nevertheless, they differed from traditional angelinvestors in that they had no expectation of aneventual liquidity event that would provide themwith not only a return of capital invested, but areturn on capital invested—a reward for theirassumed risk.

Now, contrast this “push” flow of capital with thetypical risk-seeking capital flow, wherein instead ofbeing pushed, risk capital is “pulled” into a deal bythe demand for capital: • Entrepreneurs and investment opportunities pull

early investors into investments with upsidefinancial potential, and there is an expectation offuture liquidity events. Typically, venture capitalistsdo not create the enterprises they fund; instead,entrepreneurs approach them with opportunities(and most venture capitalists reject moreproposals than they fund).

• The early successes are tempered by earlylosses.

• If early success is sustained and scaled, thiscondition pulls even more capital, and mezzanineinvestors buy out early-stage investors as a newcapital market is created.

Where this system works well—and there arenumerous examples—great wealth is created, andrevolutionary businesses are born. Along the way,the providers of capital come to learn about therisks and returns associated with the newbusinesses and investment strategies in partbecause they expect, accept and analyze failedinvestments. Furthermore, the investmentopportunities become more standardized and theemerging markets form the necessary infrastructureto facilitate future flows of capital.

In the rush and enthusiasm for creating new capitalmarkets that support blended value systems,investors must not forget this axiom of investing:

Mainstream capital is not brave. It does not like going placeswhere the rules are unclear or subject to multipleinterpretations. It does not like to go where the expectedreturns are not calculated clearly and plausibly and where therisk is not fully detailed and explained.



Furthermore, mainstream capital does not flow toinvestments simply because it might have positivesocial impact. In fact, conventional wisdomsuggests that pursuing financial return oninvestment (ROI) is agnostic at best and antitheticalat worst to social return on investment (SROI).Blended value investing stipulates that investorscan generate both types of value as an integrated,blended return, but it recognizes that investmentsmust provide the reasonably predictable potentialto generate financial ROI to attract (or pull) capitalinto deals in the first place. Without the potential forROI that approaches the risk-adjusted market ratereturn, investments will be confined to philanthropiccapital flows and will never have access to themuch larger mainstream capital flows that have ROIas their highest priority. Importantly, suchinvestments do not necessarily need to offer largeROIs; instead, it is crucial they have relativelypredictable returns subject to well-understoodrisks. This mainstream capital currently is notflowing to blended value investments in largeenough volumes, and the only way to pull it towardthese investments is to structure them so that theycan generate financial returns.

Blended value market participants must ensure thatthe present enthusiasm does not eclipse the tasksand disciplines required to build a functioning,efficient, liquid, self-correcting capital market thatwill provide ongoing, sustainable value for investorsand entrepreneurs. The balance of this paper willpresent the core elements necessary for thecreation of an effective, vibrant emerging marketnot simply for microfinance, but for the entireblended value arena made up of microfinance,social enterprise, for-profit social ventures and,indeed, any alternative financial offering that seeksto combine financial returns with social and/orenvironmental value creation.

Bringing such a global infrastructure into existencewill not be easy. While this paper sets out a seriesof goals, the path to reach them is not clear, nor isachieving them at all assured. All practitioners needto assess what structures must be created and—perhaps more importantly—what business andinvestment principles must be maintained in orderto achieve these goals. As explained later, theseemerging markets require not only new and refinedinvestment products and infrastructure, they alsoneed participants to conduct their business withgreater transparency, being more publiclythoughtful about failures and mistakes. Afundamental first step in building this infrastructureis for all potential investors in any investments thataim to generate both financial and social returns tovet each offering according to the degree to whichthe investment under consideration meets therelevant conditions described below.



Creating an Emerging Capital Market Frameworkfor Blended Value Investing

It is especially useful to examine the infrastructureof successful mainstream financial markets toevaluate the blended value capital markets’infrastructure. Mainstream financial markets workfor both investors and those seeking new capitalbecause they allow investors to evaluate potentialinvestment risk/return objectively. Virtually anymature industry that has grown to scale and hasattracted private capital has in place the followingelements:1. Common terminology2. Transparency3. Adherence to standard accounting practices4. Regulation by third parties5. Investment rating services6. Fund comparison data7. Insurance8. Liquidity through secondary markets

Microfinance is the most well developed example ofblended value investing. The industry has grown in30+ years such that at this time is has millions ofborrowers, thousands of lenders (MFIs), billions ofdollars in loan portfolios, and countless donors andinvestors with a great deal of money looking for“investment” opportunities. Further, perhaps asmany as 1,000 (an estimated ten percent of thetotal) MFIs are profitable in one way or another.

At first glance one might conclude that this industryrepresents a “breakout” – an industrydelivering a true blended value returnand doing so at scale. Upon closerexamination, one must conclude thatas good as it is, microfinance still hasnot developed the requisiteinfrastructure needed to attractmainstream capital.

Tier-One MFIs and the Overall MarketCritique

Microfinance experts segment the MFImarket in a variety of ways, oftenreferring to different “tiers” of MFIs,depending on their professionalismand financial health. (See figure 9 forone such segmentation.) Commonly,these experts distinguish about twopercent of all MFIs as “tier-one”,meaning that they have establishedtrack records, highly professionaloperations, healthy finances and,

often, many of the characteristics of commercialbanks. Many are affiliated with ACCION, Grameenand other prominent MFI networks. Tier-one MFIshave developed significant scale and expertise instructuring capital to advance social and financialreturns. Through both leveraging subsidies andloan guarantees effectively and by securing marketrate capital, these groups and their peers have leadthe overall field in its development and expansion;they pioneered and disseminated microfinance’sbest practices.

At the same time, there are many moreorganizations—98% of all other MFIs—that may bepursuing (but are still lacking) many of thecharacteristics one would expect to find in formalcapital market participants. The MFIs not includedin the tier-one designation vary dramatically fromone another, and the diversity in their businessmodels, scale and financial health cannot beunderstated. While the Tier One organizations havesucceeded in building networks and leveragingcapital, they are not even close to the entiremicrofinance market. A vast majority oforganizations both make up this larger market andfall well short of the operating capacities of tier-oneinstitutions.

While some enterprises in microfinance and acrossthe blended value investing universe dosuccessfully exhibit market-leading characteristics,the state of the overall market lags those leadinginvestments.


Figure 9: MFI Market SegmentationGrameen Foundation USA

Source: Jennifer Meehan, “Tapping Financial Markets for Microfinance”,Grameen Foundation USA, 2004


The following section assesses the broad state ofplay within the blended value investing arena byfocusing on the particular silo of microfinance. Thecritique of the broad field should not take awayfrom the work and quality organizations that havebeen created by many individuals, nor should it betaken to apply to every MFI. Rather, thisassessment raises concerns about the overall stateof the market and its implications for achieving realsustainable scale capable of tapping intomainstream financial service sectors.

Market Characteristics Explained

1. Common Terminology: Any industry must beable to describe its inner workings to outsiderswishing to evaluate performance. Microcredithas done an admirable job of developingterminology and metrics that facilitate descriptionand analysis of MFIs. Numerous industrydescriptive manuals and financial models areavailable. Unfortunately, many of thesedescriptions and associated metrics weredeveloped to identify, describe and quantify thesubsidies that are available to non-profit MFIs.Most MFIs are still operating as not-for-profitentities today and, as such, account for theiroperating results using not-for-profit terminology,this language can be confusing if not misleadingto potential investors, especially those whotypically invest only in for-profit entities. For aninvestor to understand and evaluate theoperational performance of a given MFI, theremust be a clear delineation of subsidies and therole they have played and will play in the futureperformance of the MFI.

Even the contemporary measures of financialperformance tend to evince MFIs’ non-profitorigins. The Economist’s recent survey ofmicrofinance makes this point clearly:

No matter whether those terms and acronymsare defensible or not, they clearly befuddlemainstream financial actors as represented bythe authors of the article, whose statementssuggest that microfinance’s vocabularies makethe industry appear parochial and quaint.

A second and more problematic issue withterminology is that no consistent and objectivemeasure of impact is promulgated. As thecapital markets develop and capital is “pulled” tomicrofinance, there should be objectivestandards by which investors can judge thesocial impact of their investment. Unfortunately,what passes for impact measures today isusually a simple tabulation of microborrowersserved and the average size of their loans. ManyMFIs have established their own impactmeasurement regimes, but there appears to belittle successful effort to pull those measurementschemes into a single unified approach.

Opportunities for improvement:• Commercial financiers and regulated MFIs

could continue to develop a common set ofterminology that reflects the language andassumptions of mainstream international capitalmarkets.

• After MFIs have standardized their languagearound inputs and financial performance,foundations and other NGOs might sponsorimpact-assessment studies by independentthird parties and academic researchprofessionals.

2. Transparency: As not-for-profits operating indeveloping countries, many MFIs have fewpublic reporting requirements. The transparencyof the industry is driven primarily by two factors:the decision of individual MFIs who voluntarilymake their results public and the mandatoryreporting performed by the MFIs that areregulated and therefore obligated to reportresults. Even with this level of transparency,rigorous evaluation of MFIs is difficult. MFIs inmany parts of the world now voluntarily reportresults to industry associations and these resultsare aggregated and benchmarked. For investorswanting to analyze an MFI and to compareresults to other organizations by size, geography,product, etc., the transparency issue isproblematic.


“The foggiest place in the industry is ‘on the ground’ (another favouritemicrofinance term), where familiar words suddenly become oddlyunintelligible. An item labelled ‘profit’ lets you keep mum about the lossestransferred to a money-losing charity affiliate. An 'operationallysustainable' business is one that can pay for its running costs but not itscapital, which is often the largest single expense for a financial firm. Butthe worst thing are the acronyms, which make learned analyses ofmicrofinance next to unreadable. All this may sound trivial, but industrypractitioners seem to care deeply.”76


Organizations like the Microfinance Exchange(MiX) are working to increase outsiders’ accessto the characteristics and performance of MFIs,but that information is voluntarily provided and insome cases may not be current. While manyMFI investment funds and MFI networks havedetailed information about the MFIs with whichthey work, that information is not necessarilybeing shared and aggregated in any one placeso that the MFIs’ initial transparency becomesopaque.

Opportunities for improvement:• Market participants can encourage efforts like

MiX and related efforts.• Investors and MFI networks can combine due

diligence and isolated market intelligence fromvarious actors, making them available throughclearinghouses like MiX.

3. Adherence to Standard AccountingPractices: Many MFIs operate as not-for-profitorganizations, and many control wholly ownedsubsidiaries engaged in related endeavours.Furthermore, most MFIs are not audited, andthose that are tend to use small, country-basedauditing firms. While many such firms utilizeInternational Accounting Standards (IAS),application of these standards remainsquestionable. For investors, this condition posesa problem.

Opportunities for improvement:• Market participants can form a reporting

standards-setting board like the InternationalAccounting Standards Board used todetermine generally accepted internationalaccounting standards. Such a board can focuson fitting international accounting standards tomicrofinance instead of creating a new set ofmicrofinance-specific standards.

• Any emerging accounting standards mustincorporate means of tracking subsidies as wellas their intended outcome.

• Individual investors and funds can thendemand financial statements prepared inaccordance with those standards.

• Lobbying in appropriate legislatures can ensurethat the international accounting standards willfit the emerging regulatory regimes for MFIs.

4. Regulation by Third Parties: In the developedworld, financial services businesses areregulated by governmental agencies. Alas, it isnot often the case with MFIs. In the developingworld there is often, at best, a loose regulatoryframework either in place or under development.

The net result is that MFIs function as banks butare not regulated as banks. Such mandatedperformance requirements such as capitaladequacy, liquidity, reserves, reporting, etc. areoften either non-existent or ignored. MFIs tendto be viewed by their host governments asNGOs (non-governmental organizations) and arerelatively free to operate as they wish withvirtually no oversight. For investors this conditionposes obvious risks.

This condition varies dramatically depending onMFIs’ corporate structures. In some counties,NGO MFIs can make the same loans as canregulated MFIs, while the latter will be bound bymuch more stringent regulations than the former.Countries that do regulate MFIs have regulationsthat vary from one anther dramatically (allowingor not allowing MFIs to raise capital in certainways, promulgating different capital adequacyrequirements, etc.), which forces potentialinvestors to become experts in a variety ofregulatory regimes.

The question of regulation is complicated by anumber of factors. First, many MFIs are NGOsand therefore not regulated as financialinstitutions—but some are indeed regulatedunder other frameworks. Second, regulationsdiffer from one country to the next (coordinatingthem would be overwhelmingly daunting). Finally,on a case-by-case basis, some of thoseregulations might be cumbersome andburdensome. In general it should beacknowledged that this is a significant issuebeing addressed by a number of actors.

Opportunities for improvement:• Investors like ProFund can help MFIs convert to

regulated MFIs.• Market participants can support the creation of

third-party international recommendations ortemplates for MFI regulations.

5. Investment Rating Services: Withinmainstream capital markets, most investors areunable or unwilling to conduct the type ofcomparative analysis that leads to soundinvestment decisions. Instead, they rely on third-party credit rating entities such as Moody’s,Standard and Poor’s and others. The microcreditindustry has not developed in a way that hasprompted the development of independentrating agencies, a problem that may remain inplace until MFIs and their associated financingdeals grow sufficiently large to warrant the costand attention of mainstream ratings agencies.



Early investors did not expect a “financial return”on their philanthropic investments so they hadno need for ratings. Microfinance agencies doexist, but unlike the large rating agencies, thesemicrocredit-specific rating agencies look only atmicrocredit. Accordingly, mainstream investorssee such agencies as lacking credibility,sometimes reporting in terms that do notcoincide with those used in mainstreaminvesting. As microfinance and related industriesbegin to attract funds from risk-seekinginvestors, this lack of rating services will posesignificant problems for achieving meaningfulscale. Furthermore, standardized and reputablerating agencies will lower the cost ofinvestments’ due diligence, which currentlyexceeds the typical costs associated withinitiating similarly sized investments in moremainstream markets.

Opportunities for improvement:• Ratings services such as Standard and Poor’s,

Moody’s and others must have incentives toenter this realm

• Local branches of some of these agencieshave rated some MFIs (see ACCION affiliatessection); their experience would surely bevaluable in expanding the practice.

• Here, a “smart subsidy” or creative blendedvalue investment would advance the cause if itcould creatively encourage the mainstreamratings agencies to develop microfinance ratingmethodologies and to overcome the hurdle ofscale.

• MFIs need to see value in being rated, and sofinanciers and foundations alike can give themincentives—in the form of a lower cost ofcapital or a subsidy to purchase the ratingservices—to be rated by an appropriateagency.

6. Fund Comparison Data: While there is somepublic information to allow comparison betweenMFIs themselves, virtually nothing exists to allowinvestors to compare the operating results of theincreasing number of funds investing in MFIs.For a variety of reasons, these funds are likely tobe the vehicles of significant capital flowing intomicrofinance. There are between 50 and 100 ofthese funds in operation today around theworld—with more on the way. Virtually all ofthem are private funds and publish little to nopublic data. A prospective microfinance investorhas little if any means of finding a complete listof funds, comparing their investment terms, andunderstanding their investment results and non-financial impact.

The MFI fund world is relatively small, withrelatively few actors. Accordingly, the informationon past funds should not be difficult toaggregate. Nevertheless, the relatively earlystage of many of these funds (which have notfully repaid principal lent or have not liquidatedequity investments) makes some of themhesitant to share data. A recent report publishedby CGAP aggregates data (as of 2004) on manyforeign funds (though the data are not renderedfor side-by-side comparison).77 The reportindicates that many of those funds sharedinvestors. Some funds have been focused onkeeping their investors through emotional appeal(characteristic of not-for-profit investors) insteadof through a clear statement of performance anda comparison to the investors’ other options.

Opportunities for improvement:• MFI fund investors need to invest on the basis

of expected performance and should demandperformance and comparison data.

• An independent group should study existingfunds and assemble the data in a way thatmakes comparison easy.

• The industry would also benefit from a definitiveforum (a Wall Street Journal, of sorts) in whichfund managers can announce and promotenew funds and where existing funds can reportperformance data.

7. Insurance: Most investors, or the funds inwhich they invest, are able to obtain insurance tohelp manage risk. The microcredit industry hasyet to develop the scale necessary to interestthe insurance industry. Accordingly, such thingsas foreign exchange risk, errors and omissionsrisks, directors and officer’s risk, assetappropriation risk, political risk and others aregenerally uninsurable. While there is some abilityto account for these risks through aggressiveunderwriting and risk sharing within funds, mostinvestors would appear to have few options andrelatively little appreciation of the true relative riskassociated with an investment in microcredit orsimilar offerings.

Opportunities for improvement:• The small scale of MFIs (relative to mainstream

financial institutions) will remain a barrier tocreating these insurance products, butmainstream insurers operating in MFIs’ homecountries may have the means and experienceto offer such products.



• Early iterations may need to be subsidized byother (possibly philanthropic) actors who mightprovide assets to underwrite policies thatwould be administered by the mainstreaminsurers.

• Ultimately, as the insurers learned more aboutthe associated risks, mainstream underwritingcapital would enter the market.

8. Liquidity through secondary markets: At therisk of stating the painfully obvious, for a truecapital market to exist there must, in fact, be amarket. Clearly, there is a primary microfinancecapital market where equity is placed or loansmade. From that point on, virtually all of theequity and debt invested in microfinance issimply illiquid. It can not be traded or sold freelyamong willing investors. This simple fact makesit very difficult for the average investor toconsider taking a position. At present there isnot even discussion among those in themicrocredit industry on how or when asecondary market might develop.

Opportunities for improvement:• The conditions above suggest that there is not

yet the demand to buy microfinanceinvestments on a secondary market; insteadinvestors seem interested in investing theircapital in new issues, in part because thosenew issues directly help poor entrepreneurs,while transactions on a secondary marketwould not.

• Spurring a secondary market when there seemto be no buyers would be a dubious prospect,and creating such a market place before it isdemanded would amount to a new “push”investment strategy that would likely not bearfruit.

• Pushing MFIs and investments to adhere to theconditions enumerated above would help makea secondary market more viable and likely.

Implications for the Creation of a Blended ValueCapital Market

Moving the entire industry in the direction of thetier-one institutions (and even beyond them) will bevery difficult. Traditional market forces will certainlypush some institutions in the right direction (indeed,those forces are already doing so, and they arebringing mainstream commercial banks in tomicrolending in many parts of the world).Nevertheless, subsidies—some with very legitimatesocial-value creating outcomes, and some withcounter-productive outcomes—will prevent theentire sector from looking like those tier-oneinstitutions.

At a recent conference on microfinance, BowmanCutter, Managing Partner of Wall Street investmentfirm Warburg Pincus and Chair of the Board ofmicrofinance fund Microvest, shared hisperspective on the state of the microcredit capitalmarket. Cutter spoke at length about the effort,time and resources expended to bring Microvestinto being.78 He observed that he and hiscolleagues created from scratch virtually all of theirwork; they had no templates or standardprocedures to use as models. He observed that ifevery step toward building a microfinance capitalmarket turns out to be as hard as startingMicrovest, maybe the industry should rethink itsstrategy.

Fortunately, Cutter also provided real hope. Henoted that he started in the investment bankingprofession more than 30 years ago. At that time,the profession was effectively in a start-up modeand that everything they did then was a “one-off”creation. He noted that today investment banking isa robust and very successful industry attracting andsuccessfully managing billions of dollars annuallyand that microcredit feels like investment bankingdid 30 years ago.

The success of investment banking was built on afirm's appetite for capital and an investor's desireto put capital at risk. That situation exists today inthe broad range of BVI investment opportunities.The microfinance business needs many billions ofdollars to fund loan portfolios so that hundreds ofmillions of people can begin to create income andwealth and ultimately raise themselves frompoverty. Similar demand for capital exists in the BVIsegments that would fund affordable housing andcommunity development, environmental protection,health, education and related services for the poorin all countries. As was the case in microcredit



there are many case studies that could have beenadded to those in this paper to make the point thatthere are successful, hard-won interventionsalready in the market.

However, there are a number of steps that precedethe creation of this blended value capital market.

Silos Versus Value Chains

First, blended value market participants, bothinvestors and investees, must collaborate acrosstheir relative areas of interest (for examplecommunity development finance and bankingactors could work more directly with microfinancepractitioners to address common challenges). Allshould work to “come out of their silos”.

Silos breed isolation and the need of everyorganization in a given field of endeavour to doeverything in virtual isolation. When applied toindustries such as microcredit or communitydevelopment, it means the major players withintheir respective organizations are both vertically andhorizontally integrated. They build theirorganizations and attendant support structures.Because the connecting tissue that ties entitiestogether into value chains is not present, they goabout doing everything for themselves. Theydevelop no set of core competencies that whenpaired with others with different core competenciesallow the formation of a true network of firms allaligned in their purpose and relying on each others'strengths to add value to the end customer.

These value chains or collaborative networks arehow business is done in the for profit arena. Oneneed only look as far as a Wal-Mart, Boeing orCisco Systems to see business models based, attheir very foundation, on the assumption thatnetworks add value; going it alone does not.

What are the implications of this for thoseinterested in building a blended value capitalmarket? Leaders in the various BVI areas couldconstruct value chains, ensuring their organizationsdevelop core competencies and distribute commonwork. What is more, they should reach out toexisting players operating outside their BVI areaand enlist them in this effort.

This is exactly what the Calvert Foundation did bygoing to the Depository Trust Company (DTC) tohandle the clearing and holding of communityinvestment notes. The foundation knew this servicewas vital to its business model. It also knewmainstream investors require such a service. Rather

than build an alternative or survive without it,Calvert Foundation created with DTC a value chainthat added value for the customer. In reflecting onhow the case studies presented in this paperevolved, one is struck by how often the successfulinitiative was characterized by the sponsor reachingout to others and building value chains.

Value chains are resource-conserving by design. Asuccessful value chain involves bringing togetherthe best firms in a way that minimizes overlap orredundancy. Who, exactly, benefits whenredundancies are eliminated and the very bestplayers are joined along a line where each is therebecause of a core competency? Quite simply,everyone. Scarce resources are preserved, firmsare there because they add value in their areas ofstrength and investors get the best return becausethe customers get the best good or service at thebest price. The value chain should become themodel of how every BVI initiative is organized.

The second and concluding thought is that thisprocess will take time—a lot of time—and willrequire the building of systems that are, today, notin place. The time is necessary because, at itsmost basic, building successful BVI initiativescapable of attracting and rewarding large amountsof capital is about changing culture—the culture oftraditional financial services groups, NGOs,foundations and other participating entitiesstructured to address the needs of either for-profitor non-profit actors. Conceptually and technically, itreally is not hard to imagine microcredit oraffordable housing or community developmentbeing able to arrange themselves into competitivevalue chains. In most cases the leaders of thevarious BVI segments have a foot in each world,the economic and the social. Their employees,boards and stakeholders expect them to bemission-oriented yet financially successful. That isvery hard to do and requires that culture change toaccommodate the needed alteration in missionexecution.

But if it will be hard for the operators of BVendeavours to change culture, imagine how hard itwill be for investors. The dominant culture assertsthat one cannot mix mission with money. Even thesocially motivated investor merely winks at thenotion that a very well-run microfinance institutioncan address poverty and earn a respectable returnon investment. They hear the story and see thepictures but suffer a cognitive dissonance. Thisdissonance is, of course, what led the founders ofthe microcredit industry to initially approachphilanthropists.



A Progression of Investors

Many critiques of microfinance-backed assetsaddress barriers to the widespread adoption ofthose securities by institutional and othermainstream investors. While emerging blendedvalue capital market participants must not forgetthis investor segment is its long-term goal, it wouldbe wise to pursue a systematic plan that will bringthese investments ever closer to that mainstreaminvestor pool by targeting other strategic investorswho can help advance the cause.

Most institutional investors require a defined assetclass (wherein the securities bear a certainuniformity of structure so that the securities’behaviour can be better understood if notpredicted). Most mainstream market participantswould assert that most blended value investmentproducts can not yet be considered legitimatemembers of an asset class. In spite of the recentand effective productization of microfinance bonds,the issues remain too different, there remain toofew of these securities, and they have existed fortoo little time for financial analysts to understandtheir aggregate behaviour.

Furthermore, institutional investors with fiduciaryresponsibilities will often not even invest in a newfund or investment product in the mainstreamcapital markets. Typically, professional investors willavoid fund managers and funds that do not have ademonstrated multi-year track record of managingthat particular investment with that particularinvestment style. They do so because they need tobuild the expected performance of any giveninvestment into sophisticated asset allocation andportfolio models. As long as such quantitativemodels are built on historical performanceinformation, such investors will need to wait foryears until blended value securities can reachsufficient scale and can generate several years ofperformance data. This condition is a factor of timeand it cannot be accelerated.

Instead, market participants offering blended valueinvestments can target other investors strategically(as indeed many already have). Currently, it is a rareblended value investor who can construct areasonably diversified portfolio even ofmicrofinance-backed investments. To do so,investors must have sufficient capital (in the tens ifnot hundreds of millions of dollars) to dedicate tosuch a portfolio, and they must have a dedicatedstaff that can research potential deals and canthoughtfully assemble it.

Thus far, many of these investors have beendevelopment banks and foundations that have boththe scale of investment and staff to effect it. Thiscondition leaves high net worth individuals—thosewith limited staffing resources and a desire todeploy capital in the hundreds of thousands to thelow millions of dollars—limited options for blendedvalue investing. As more and more such investorsexpress interest, there may be a place forinvestment funds that can syndicate high net worthindividuals’ investments and then place those fundsinto a well-diversified portfolio of blended valueinvestments. Such intermediaries could help theseinvestments get “pulled” closer to mainstreaminvestments by making them accessible to the nextstage of investor (after the way has been blazed bydevelopment banks and foundations). If thesefinancial intermediaries build properly diversifiedportfolios, they will be able to sustain theoccasional inevitable losses on individualinvestments.

When high net worth individuals can buy blendedvalue investments, they will eventually andincreasingly ask their professional wealth advisersto incorporate such investments into their overallportfolios. Those advisers, in turn, will bring a newset of mainstream capital resources to bear onthese emerging investments as they research andanalyze these new investments.

Accordingly, blended value market participantsshould continue to focus on “socially responsibleinvestors”, individuals who would purchase blendedvalue investments first because of their expectedSROI and second because of their expected ROI,because those investors can help these assetclasses establish a track record and because theycan bring additional resources to bear on theanalysis of such assets. Nevertheless, in doing so,advisers and investors must diligently focus on thefundamentals and risks of such investments asthough they were purchased purely for theirexpected ROI.

Failing Forward

In any market, particularly an emerging market thathas few precedents, there will be occasionalimbalances of supply and demand. At times priceswill be too high, and at other times they will be toolow. As the markets learn to price risk and digestmarket and non-market events, prices will likelyswing; some people will make money, and somewill lose. The blended value capital markets mustanticipate this sort of volatility and must face itwithout avoiding it.



Market participants should structure theirinvestments so that market shocks engendermarket corrections, not market collapses. Keys todoing so are diversification (at least in terms ofgeography, financial instrument and fund managers)and conscious risk mitigation. As mentionedelsewhere in this study, foreign exchange riskremains largely unmitigated in many internationalblended value financing strategies. Drastic currencydevaluations have the potential to destroy returnsand collapse private-investor-supported markets forinternational lending unless market participants candevelop facilities to understand and begin tomanage foreign exchange risks.

Fortunately, a number of such initiatives are underdevelopment. Investment advisers such as Omtrixand others have been at the forefront of advancingsuch foreign exchange hedges where they have notexisted in the past.

Furthermore, open communication aboutinvestment methodologies, pricing, failures andequity-holders’ profits will be essential to pricingthese blended value investments correctly. Keepingthe data private introduces the chance that otherfunds will erroneously price risk. When substantialcapital enters (or fails to enter) a market based onmispriced risk, that market is prone to dramaticfailure. Markets cannot accurately price the riskassociated with their securities unless they openlyexplore failures as well as successes.

Investors must also be exceedingly rigorous aboutentering and exiting investments. They must beespecially careful to understand how the drive tocreate SROI can affect an inclination to enter ill-advised investments and their decisions to exit (ornot exit) underperforming investments. Investorsmust have the fortitude to take losses and cut offinvestments that are not obviously salvageable.

The emerging blended value capital markets simplycannot afford for participants to be secretive abouttheir data, ashamed of their failures, or fragmentedin their terminology.

Conclusion

This paper explores various capital structures thathave successfully been used to financemicrofinance, community development and relatedareas. We suggest these blended value investingpractices be extended to other value-generatingprojects or sectors. It must be stated that such aprogression will not be easy, swift or painless.Microfinance has the benefit of over 30 years ofrefinement—a three-decade head start on otherblended value investments. Furthermore,microlending itself has some very appealingcharacteristics that are not necessarily shared byother blended value strategies. The fundamentaleconomics of microfinance are so strong becausethey are built on many loans to many peoplediversified across business sectors. Given thatthose microentrepreneurs are operating inpredominantly cash-oriented economies, oftentimes providing essential goods and services, theyare somewhat insulated from macroeconomicfluctuations. Furthermore, those entrepreneurs canshift their businesses very quickly, exiting andentering new business areas as conditions dictate.

Other potential blended value investment vehiclesmay not possess such appealing risk-rewardfundamentals. Accordingly, investors andintermediaries will need to structure and priceinvestments such that they account for thoseunique risk characteristics. Microfinance’s lessonscannot be applied wholesale and unthinkingly toother blended value investment systems.Nevertheless, the market participants aiming tobring new capital flows to low-cost housing, smallscale irrigation, and so many other systems canand should learn from the laborious 30+ yearjourney that microfinance and its capital marketshave undertaken. Undoubtedly, much can belearned from careful research into the majormicrofinance innovations that led it from aphilanthropically supported enterprise to onesupportable by mainstream capital. Building uponthe great strides made by those within microfinanceand community banking, sustainable financialinnovations hold the promise of expanding intocountless areas of both social need and marketdemand.



Dramatic Expansion of Services

Over the past decades, MFIs have grown in scaleand travelled around the world, and today manyoffer an ever-expanding array of services. In manycases the infrastructure created to establish andservice microcredit may be leveraged across manydifferent services and programmes. Grameen Bank,one of the oldest and most establishedmicrofinance institutions, has dramaticallyexpanded its services, to the great benefit of thepeople whom they serve. Grameen has extendedits technical know-how to offer many additionalservices through a loose network of affiliatedcompanies, which it calls the “Grameen Family ofEnterprises”, which includes education,telecommunications and textile manufacturingenterprises (among others).

Savings and Equity for MFI Customers

As MFI clients become increasingly financially self-sufficient, many MFIs have encouraged andfacilitated savings and deposit programmes.Furthermore, some MFIs are now exploringfinancing structures that allow clients to purchaseequity in the MFI.

Early microfinance efforts focused only on loans,and many MFIs handled savings clumsily. Somepeople even perceived that the poor might makeviable borrowers who could not be effective savers.The problem was further compounded byregulations in many markets where MFIs operated.Many states regulate financial institutions that canaccept deposits in order to protect savers andinvestors and many MFIs began (and many still are)as not-for-profit or informal entities, which in manycases precluded them from accepting deposits.

As MFIs have refined their lending models andmoved toward greater financial sustainability, manyhave become formalized and regulated so they canaccept their borrowers’ savings deposits as well.Accepting and then managing deposits often callsfor the development of a new set of competencies,but those MFIs that can learn them and institutesavings and deposit programmes offer their clientsvital services while gaining a potential source oflow-cost capital that can be re-lent to otherborrowers.

MFI Networks

Established networks of MFIs spread best practicesand offer technical assistance, increased visibility,and public validation for established and emergingMFIs alike. For investors in MFIs, the networks canbegin to establish relationships between holders ofcapital and potential investees. MFI networks areoften geographically specific and can give an MFIinvestor exposure to specific markets. Servicesoffered by MFI networks to their constituents varywidely, especially as they pertain to potentialinvestors. Some MFI networks seed MFIs in newmarkets with capital and expertise, thus creatingthemselves as networks, while some generate theaffiliation after the constituent MFIs.

The Formal and Informal Banking SectorsConverge

As the services offered by MFIs increase and theinstitutions’ clients improve their financial status andrequire more formal banking products, many MFIsare moving “up-market”. As the scale of theirfinancial products increases, the nature of thoseproducts also tends to increase. Existing customerswill establish personal credit records—and moresignificant sources of income—permitting MFIs tooffer loans with any source of social collateral. Asthe upwardly mobile MFIs provide bankingproducts that resemble those of a typical consumerbank in the developed world, their costs tend to fallas well.

Meanwhile, major local and international bankshave observed the opportunities in microfinance,with many now moving “down-market” by offeringfinancial products to people who were previously“unbanked”. It should be no surprise, then, thatmany banks have established partnerships withMFIs who have developed the expertise and holdthe knowledge required to service the informalsectors on a financially sustainable basis.

Adoption of Technology

Technological advances are beginning to reducethe expense of servicing microloans, which in turnhas the potential to make new lending modelsavailable. Beyond financial management informationsystems (MIS), many MFIs are now usingtechnology developed for established, mainstreamfinancial service firms.

Appendix A: Other NotableDevelopments in Microfinance


Share Mircofin Limited and Smart Cards

In collaboration with Venture Infotek, an Indiancorporation that provides payment transactionprocessing solutions to banks and relatedbusinesses, SML has integrated smart-cardprocessing into is core lending business. Theprogramme’s pilot issued smart cards that couldtrack multiple accounts. These cards store theclients’ personal data along with details about theirloans. Handheld terminals used by SML staff updatethe information stored on the cards, print paperreceipts, track changes in the clients’ status, andstore the data, which is ultimately up-loaded to SML’scentral enterprise systems.

SML summarizes the programme as follows:

The programme is a smart-card-based, integrated paymentsolution designed for automated loan tracking withintegrated features like risk management, automatic loanapplication scoring, on-the-spot updating of loan records,on-the-spot repayment, customized MIS reports, automaticlate payment/penalty calculation, zero fraud tolerance, true“anytime-anywhere” loan reconciliation, identitymanagement, low cost of entry and easy-to-learninterface.79

The MFI’s early assessment of the programmedeemed it a success: “The new system has reducedthe time of centre collection by 60-75% and branchrecords updating by 80-90%. This would help in along way in increasing efficiency of the entireoperations [sic].”80

Hewlett-Packard’s Remote Transaction System(RTS)

Developed in concert with several MFI networks,HP’s RTS deploys “a combination of wirelesstechnologies, smart cards, standards-basedsoftware, commodity PCs and business processes”to enable MFIs to gain access to rural communities.81

Like the SML pilot, HP’s 2004 pilot project usedsmart cards and hand-held readers to increase theefficiency of processing microloans. HP’s hardwareand software were designed specifically for flexibility,durability, simplicity and scalability. Lessons learnedinclude the following:• Business process improvement is as important as

technology innovation;• High-level management buy-in and ownership

across the organization are necessary for success;• Scale at an industry level will require

standardization and shared infrastructure inaddition to competition.82

MFI Standards, Rating and Auditing

Through technological innovation and business processimprovement, the microfinance sector is growing to asignificant scale. As practices are refined, costs fall, andscale increases, potential investors and practitioners alikehave moved to increase transparency and standardizationof MFI practices and performance, though much workremains to be done.

The Microfinance Rating and Assessment FundThe Microfinance Rating and Assessment Fund wasfounded in 2001 by the Inter-American Development Bank(IDB) and the Consultative Group to Assist the Poor(CGAP). The Fund co-finances ratings and assessments ofMFIs through independent, professional ratings agencies.The reports, which the Fund makes publicly available on itswebsite, assess credit and other risks associated with thedifferent institutions.83 Information on the Fund’s ratingpartners is also available.84

The MIXThe Microfinance Information eXchange (MIX), was foundedin 2002 to disseminate information on the microfinancemarkets and ultimately to encourage standardization andtransparency by providing detailed information on MFIs,their partners and investors.85 MIX has two primaryproducts, MIX MARKET, a Web-based information clearinghouse, and MicroBanking Bulletin (MBB), 86, 87 a source formicrofinance performance benchmarks. Additional lists ofrating agencies may be found at the Global DevelopmentResearch Center.88

Other MFI-Specific Ratings InstitutionsWithin the MFI sector, a number of MFI-rating entities havearisen. Many of them seem suited primarily for internalindustry use. Drew Tulchin, of Grameen Foundation USA,writes of these microfinance-specific ratings: “Althoughthese efforts do increase transparency and standardization,they also obscure ready analysis by outsiders. Evaluationtools are increasingly specialized, thus decreasingcomparability with other development or investmentchoices.”89 Tulchin continues to observe that many existingMFI metrics (average loan size, number of clients andothers) do not address the needs and interests of potentialinvestors.

Despite these drawbacks and while various ratingmethodologies seem to abound—some doubtlessly betterthan others—on the whole, these rating methodologies andagencies represent the early steps needed to createinternationally recognized ratings agencies on a par with aStandard and Poor’s, Moody’s or other mainstream ratingshouses. Such advances will be critical to achieving the levelof transparency required to create a truly liquid capitalmarket.

Appendix A: Other NotableDevelopments in Microfinance


Compiled by Shari Berenbach of CalvertFoundation with Jan Piercy of ShoreBank

Alternative Investments: Term used by religiousinvestors for the last twenty to thirty years to referto private investing with social goals. This shouldnot be confused with the more conventionalfinance use of this term which refers to non-liquidfinancial instruments and classes such ascommodities, private equity, oil wells, real estate,etc.

Blended Value Investing: A term first coined byJed Emerson, this approach recognizes that valueis non-divisible and naturally incorporates social,ethical, environmental or charitable elements. Theconcept of blended value has many implications forboth organizations and capital managers. In thecontext of this paper, blended value investingencompasses all classes of investments pursuingsuch multiple goals, including socially responsibleinvestments and private investment for social goals.See, “The Blended Value Map” by Jed Emerson, et.al. at www.Blendedvalue.org for additional papersand materials on corporate social responsibility(CSR), socially responsible investing (SRI), socialenterprise and sustainable development, and howeach of these arenas fit within a broader, valuemaximizing worldview.

Community Development Venture Capital(CDVC): Funds that extend early stage equityfinancing or quasi-equity investment products intosmall enterprises typically owned and operatedwithin disadvantaged communities. Some US$ 600million has been invested in diverse funds in the USand abroad. Many US funds are members of theCommunity Development Venture Capital Alliance.A relatively recent financial strategy to promotecommunity development, most CDVC funds havenot completed an investment cycle, exited ordistributed returns to their investors.

Community Development Financial Institutions(CDFIs): A term used for community-basedfinancial intermediaries with a principal mission toservice low-income populations. CDFIs are certifiedby the CDFI Fund, a US Department of Treasuryprogramme. Some CDFIs are for-profit, regulatedcommunity banks and credit unions, while othersare non-regulated, non-profit loan funds.Community development venture capital funds alsoqualify as CDFIs.

Community Investment: Term popularized by theUS socially responsible investment industry to referto direct investment into community-basedintermediaries with the objective of benefitingdisadvantaged communities. Many communityinvestment options are relatively low risk, such asdeposits in regulated CDFIs or notes intocommunity-loan funds. Typically these instrumentsprovide a less than risk adjusted financial return. Inrecent years, community investment has begun toincorporate higher risk sectors such as communitydevelopment corporations, social enterprises andcommunity development venture capital. Returnsfrom these newer market segments are lesspredictable. Approximately US$ 13 billion has beenchannelled to community investment intermediariesin the US.

Ethical Investments: More commonly used inEurope and the United Kingdom, ethical investing isbroadly similar to socially responsible investing (seebelow). Investors incorporate ethical considerationsinto their investment process, rely on "reflexive"strategies such as screening and shareholderadvocacy, and seek market rates of return.

Financial Intermediary (FIs): Financialintermediary or financial institution such as afinance company, development finance corporation,commercial bank or other kind of financialinstitution providing financial services to small- andmedium-sized enterprises or other sectors.

Grassroots-based Business Organizations(GBOs): A term recently popularized by theInternational Finance Corporation, GBOs may beprivately-owned small- and medium-sizedenterprises or those owned and operated by non-profits that involve local production and/ormarketing and distribution channels. GBOs typicallycombine profitability objectives with private sectorstrategies that benefit local small producers.

Microfinance Institutions (MFIs): Typicallyassociated with local financial intermediaries indeveloping or transitional economies, MFIs providevery small loans to informal sectormicroenterprises. Microfinance institutions may benon-governmental organizations, specializedregulated financial intermediaries or full commercialbanks and some provide financial services to smallbusinesses in addition to microenterprises. In mostinstances MFIs connote a distinct stand-alonefinancial intermediary, but in other instances theymay be a department of a larger commercial bankor development programme.

Appendix B: A Glossary of Blended ValueInvesting Terms


Programme Related Investments (PRIs): A termdefined by the US tax authorities, PRIs areinvestments made by a philanthropic institution withthe primary objective of furthering its mission. Mostprogramme related investments are structured asbelow-market loans or long-term equityinvestments into development financeintermediaries or non-profit social enterprises.

Private Investment with Social Goals: A termcoined for this meeting, this refers to investment ofcapital to promote a specific social orenvironmental agenda. Private Investments withSocial Goals includes blended value investing thatincorporates financial instruments offering bothmarket rates and below-market rates. Differentfrom socially responsible investment that reflectsinvestor values, these investments promote socialimpact.

Shareholder Advocacy: A common strategyamong socially responsible investors, this entailsproposing shareholder resolutions and/or proxyvoting in order to influence corporate policies infavour of social objectives.

SMEs: Small- and medium-sized enterprisestypically served by local commercial banks indeveloping or transitional economies. Some MFIshave gone up-market to reach SMEs and somefinancial intermediaries that historically servicedSMEs are now downscaling into the MFI market.

Social Enterprise: Social enterprise typically refersto non-profits or non-profit-owned subsidiaries thatincorporate commercial discipline within theiroperations and seek to generate a surplus (e.g.,profit) that is returned to the non-profit owner tosupport its mission.

Socially Responsible Investing: Sociallyresponsible investing is the broad term used todescribe investments that reflect investors' moraland ethical beliefs. SRI instruments are typicallypublicly traded funds that return to investorsmarket-rate, risk-adjusted financial returns and areexemplified by socially responsible mutual fundssuch as Calvert, Domini, Pax World Fund, amongothers. Socially responsible investing usuallyincorporates screening of investment companiesand shareholder activism through proxy voting. SRIinvestment strategies in the US represent morethan US$ 2 trillion or approximately one in eightdollars invested. The Social Investment Forum inthe US recommends that all SRI Investors alsoengage in community investment – (seeCommunity Investment).

Social and Environmental Screening: Negativescreening entails the practice of screening out ofinvestment portfolios financial instruments issuedby companies with deleterious social andenvironmental impacts. Positive screening involvesselecting for inclusion in portfolios instrumentsissued by companies with business practices thatresult in positive social and environmental impacts.Screening is typically associated with sociallyresponsible investment.

Social Venture Capital: This refers to venturecapital that seeks to attain social and/orenvironmental value as well as financial return,incorporating early "angel investors" as well asmore conventional stage venture capital. The typesof social objectives pursued range fromenvironmental, alternative lifestyle, healthyproducts, etc. Most social venture capital fundsseek competitive market returns and do notexplicitly strive for poverty alleviation or socialjustice goals associated with communitydevelopment venture capital (see above.) The US-based Investors' Circle is a well-known associationof professionals engaged in social venture capital.

Triple Bottom Line Investing: Triple bottom lineinvesting returns to investments that seek togenerate social, environmental and financialreturns. Triple bottom line investing is closelyassociated with "reflective" investment strategiesassociated with socially responsible investing.

Venture Philanthropy: This form of grant-makingis distinguished by the high level of involvement bythe donor and larger, longer-term grant-makingassociated with performance goals. Venturephilanthropy may entail support of socialenterprises owned by non-profits and/or othermore conventional non-profit activities. Althoughfinancial terminology may be used by grant-makersto underscore a business-like approach, venturephilanthropy should not be confused withcommunity investment. Funding is provided on agrants basis; there is no expected financial return.

Appendix B: A Glossary of Blended ValueInvesting Terms


The body of this paper was authored by JedEmerson and Josh Spitzer.

Jed Emerson is a Senior Fellow with GenerationFoundation, of Generation Investment Management(London/Washington, DC). He has served as theBloomberg Senior Research Fellow in Philanthropyat Harvard Business School, a lecturer in businessat Stanford Business School and a Senior Fellowwith the William and Flora Hewlett Foundation.Emerson’s focus of work is on the concept of theBlended Value Proposition and a Unified InvestmentStrategy for foundations and other asset owners.Please see www.blendedvalue.org for more onthese topics.

Josh Spitzer develops curriculum and pursuesresearch in the Center for Entrepreneurial Studiesat Stanford University’s Graduate School ofBusiness. He collaborates with professors,entrepreneurs and investors to advance the field ofentrepreneurial studies and help train MBAstudents. He holds an MBA from Stanford'sGraduate School of Business and a BA fromCornell University.

The paper’s conclusion was co-authored with GaryMulhair.

Gary Mulhair is the Managing Partner of GlobalPartnerships, a Seattle-based non-profit engaged inpoverty elimination through financing LatinAmerican microcredit and a US based advocacyeffort. Mulhair manages the investment activities ofGlobal Partnerships and has long been engaged inthe development of sustainable approaches toaddressing social issues

The authors would like to thank the CiscoSystems Foundation for grant support that madethis research possible, as well as the GenerationFoundation for staff support which alsocontributed to this project’s completion.

We would also like the thank the members of theWorld Economic Forum’s Foundation LeadershipGroup who proposed the inclusion of many of theexamples contained in this report.

Finally, this research would not have been possiblewithout the support of Adele Simmons,Philanthropic Adviser to the World EconomicForum, as well as other Forum staff. We would liketo gratefully acknowledge their contributions to thisdocument.

The authors gratefully acknowledge each of thefollowing individuals who thoughtfully andgenerously helped shape this document byreviewing drafts and offering commentary.

Acknowledgements

Gillian Arthur Actis Capital LLPCedric de Beer NurchaShari Berenbach Calvert Social Investment FoundationPaul Christensen ShoreCap International LtdBill Clapp Global PartnershipsStuart Davidson Labrador VenturesSusan Davis Grameen Foundation USAPeggy Dulany Synergos InstituteJohn Ferguson Goodwin Proctor LLPRoger Frank Developing World MarketsTimothy Freundlich Calvert Social Investment FoundationRien van Gendt Van Leer Group FoundationPaul Herman Omidyar NetworkForest Himmelfarb ShoreCap International LtdPeter Johnson Developing World MarketsJacqueline Khor The Rockefeller FoundationSimone Lee Developing World MarketsJonathan Lewis MicroCredit Enterprises, LLCAsad Mahmood Deutsche Bank AGHarlan Mandel Media Development Loan FundCamilla Nestor Grameen Foundation USAAmber Nystrom Social FusionMaria Otero ACCION InternationalStewart Paperin Open Society InstituteJan Piercy ShoreBank CorporationLynn Pikholz ShoreCap Exchange CorporationVineet Rai Aavishkaar India Micro

Venture Capital FundElisabeth Rhyne ACCION InternationalAlejandro Silva Omtrix S.A.Peter Tavernise Cisco Systems, Inc.Klaus Tischhauser responsAbility Social

Investment Services AGBrian Trelstad Acumen FundArthur Wood Ashoka


1 Excellent resources that explore the current state ofthe microfinance sector include the International Yearof Microcredit website,http://www.yearofmicrocredit.org, the MicrofinanceGateway, http://www.microfinancegateway.org, andthe Microfinance Information eXchange,http://www.themix.org.

2 Meehan, Jennifer. “Tapping Financial Markets forMicrofinance”. Grameen Foundation USA (GFUSA).2004. This report presents a comprehensiveassessment of microfinance institution access tocapital markets, including a discussion of theobstacles to the practice. This and other publicationscan be downloaded from GFUSA’s website:http://www.gfusa.org/newsroom/books_and_publications.

3 Ibid.4 This section draws significantly on conversations with

Maria Otero, CEO of ACCION International, andElisabeth Rhyne, Senior Vice-President of ACCION.

5 This section and the one that follows it summarizeinformation presented in: Lopez, Cesar. “MicrofinanceApproaches the Bond Market: The Cases of Mibancoand Compartamos”. Small Enterprise DevelopmentJournal. Vol. 16, No. 1. March 2005.

6 A basis point is 1/100 of 1%. The measure is typicallyused in reference to bond yields.

7 Meehan, Jennifer. “Tapping Financial Markets forMicrofinance”. Grameen Foundation USA (GFUSA).2004. pp. 9-10.

8 Ibid, p. 12.9 This case study draws significantly on conversations

with Gary Mulhair at Global Partnerships and withRoger Frank, Peter Johnson and Simone Lee atDeveloping World Markets.

10 Global Partnerships.http://www.globalpartnerships.org. December 2005.

11 Investment advisers and sponsors were engaged inthe private placement of this particular deal when thispaper entered editing; accordingly, the advisers haveasked that the fund not be identified here.

12 The authors gratefully acknowledge Jonathan Lewis ofMicroCredit Enterprises who articulated this point ininterviews cited later in the document.

13 One must not assume that a lack of financial return tocapital market investors necessarily indicates wastefulor inefficient microfinance administration. While indeedinefficiency may destroy the potential returns, theremay also be legitimate social value creation strategiesthat are not compatible with generating returns toinvestors. More data and transparency about MFIoperations are required for investors to develop adeeper and more nuanced understanding of howadministration costs and social value creation invarious circumstances can influence financial returns.

14 This case study draws significantly on conversationswith Harlan Mandel, Deputy Managing Director ofMedia Development Loan Fund, and with ShariBerenbach, Executive Director of Calvert SocialInvestment Foundation.

15 Reprinted from the Calvert Foundation case study.

16 For additional details, please seehttp://www.time.com/time/europe/magazine/article/0,13005,901041227-1009841,00.html andhttp://www.mdlf.org/look/mdlf/article.tpl?IdLanguage=1&IdPublication=20&NrIssue=1&NrSection=70&NrArticle=793.

17 Depository Trust Company. “About DTC.”https://login.dtcc.com/dtcorg/home/page18832.html.December 2005.

18 More information on the Latin American Bridge Fundand is successor, the Global Bridge Fund, can befound in ACCION’s periodic publication InSight.Number 15, published in September 2005, is devotedto those funds and the concepts of loan guarantees. Itcan be downloaded at http://www.accion.org/insight/.

19 Ragin Jr, Luther. Presentation at Stanford UniversityGraduate School of Business. 25 October 2005.

20 This case study draws significantly on conversationswith Cedric de Beer, Managing Director of Nurcha,and with Stewart Paperin, Executive Vice-President ofthe Open Society Foundation.

21 Founded in 1996, the resulting programme is calledthe National Housing Financing Corporation. Whollyowned by the South African government, thisfinancing intermediary facilitates mortgage lending tolow and moderate income families.

22 The Open Society Institute’s Mission: “The OpenSociety Institute (OSI), a private operating and grant-making foundation, aims to shape public policy topromote democratic governance, human rights, andeconomic, legal, and social reform. On a local level,OSI implements a range of initiatives to support therule of law, education, public health and independentmedia. At the same time, OSI works to build alliancesacross borders and continents on issues such ascombating corruption and rights abuses.” Moreinformation on OSI can be found athttp://www.soros.org.

23 Nurcha. Annual Review, 2004. Available atwww.nurcha.co.za.

24 De Beer, Cedric. “Expanding Nurcha’s Role: AProposal for Consideration.” Unpublishedpresentation. December 2004.

25 This case study draws significantly on conversationswith Asad Mahmood, Director of the CommunityDevelopment Group at Deutsche Bank, and oninformation available athttp://www.community.db.com.

26 This case study draws significantly on conversationswith Jonathan Lewis, CEO of MicroCredit Enterprises,LLC, and with John Ferguson, a partner resident inthe New York office of Goodwin Procter LLP.

27 MicroCredit Enterprises. Comprehensive InformationalMemorandum. Edition No. 4, September 2005.

28 Such as Freedom from Hunger, Grameen, ACCION,Pro Mujer, and Unitus.

29 This case study draws significantly on conversationswith Camilla Nestor, Growth Guarantees Manager atGrameen Foundation USA.

30 Citibank, it should be noted, has made significantpublic commitments to microfinance. Coverage in thebusiness press includes mention in “The HiddenWealth of the Poor: A Survey of Microfinance”. TheEconomist. 5 November 2005.

Endnotes


31 Grameen Foundation USA. “GFUSA GrowthGuarantees: A Guarantee Financing Program forPoverty-Focused Microfinance Institutions.” Undatedwhite paper.

32 “GFUSA Announces Guarantee Program to Offer upto US$ 50 Million to MFIs”. Grameen Foundation USApress release. 15 September 2005.

33 This case study draws significantly on conversationswith Asad Mahmood, Director of the CommunityDevelopment Group at Deutsche Bank

34 Merrill Lynch. "Leading Institutional Investors andDevelopment Agencies Launch the Global CommercialMicrofinance Consortium; Landmark GlobalCollaborative US$ 75 Million Fund for Micro-Entrepreneurs”. Press release. 3 November 2005.http://www.merrilllynch.com/?id=7695_7696_8149_46028_50022_50023.

35 Ibid.36 NGO Transparency International reports on the state

of corruption in various parts of the world. Itscorruption-tracking indices can be found athttp://www.transparency.org/surveys/index.html.Various other useful resources are available on theorganization’s website.

37 The Development Data Center of the World Bank inWashington, DC publishes a book called WorldDevelopment Indicators, which presents informationon various countries' business environments. Fromthose data, one could begin to assemble anunderstanding of different countries' bureaucraticenvironments.

38 Community development investing deploys capital in agiven location with the intention of strengtheningcommunities by enhancing economic opportunities,increasing civic engagement and developingcommunity assets.

39 Community Development Venture Capital Alliance.http://www.cdvca.org.

40 Clark, Catherine and Josie Taylor Gallard. “RISECapital Market Report: The Double Bottom LinePrivate Equity Landscape in 2002-2003”. ResearchInitiative on Social Entrepreneurship. ColumbiaBusiness School. August 2003.http://www.riseproject.org/uzrise_capmkt_rpt_03.pdf.December 2005.

41 Pacific Community Ventures. “Sustaining StrongReturns.”http://www.pacificcommunityventures.org/publications/2004-PCV-ExecutiveSummary.pdf

42 Expansion Capital Partners.http://www.expansioncapital.com.

43 Solstice Capital. http://www.solcap.com. 44 Investors’ Circle. http://www.investorscircle.net. 45 This case study draws significantly on conversations

with Alex Silva, President of Omtrix SA and CEO ofProFund.

46 By February 2006, ProFund had exited all of itsinvestments but had not yet collected on three of itsliquidations. One such delayed collection included atax reimbursement from the government of Columbia.The fund’s management contract with Omtrix hadexpired, though the management company continued

to provide collection services on an as-needed basis.Silva estimated that the fund would complete finaldistributions to shareholders by mid-2006.

47 Rhyne, Elisabeth. “Perspectives from the Council onMicrofinance Equity Funds.” Small EnterpriseDevelopment Journal. Vol. 16, No. 1. March 2005.

48 Further information on the Council of MicrofinanceEquity Funds and the investment practices it supportscan be found at http://cmef.com/.

49 Silva, Alex. “Investing in Microfinance: ProFund’sStory”. Small Enterprise Development Journal. Vol. 16,No. 1. March 2005.

50 This section of the case study draws on the followingpublication: Silva, Alex. “Investing for Profit in Microand Small Businesses: The ProFund Experience.”Office of Development Studies, Bureau forDevelopment Policy, United Nations DevelopmentProgramme. Undated draft.www.undp.org/ods/areas/area-3/area-mm/Silva5fin.doc.

51 ProFund’s experience during these emergencies led tothe creation of the Emergency Liquidity Facility (ELF),also administered by Omtrix. ELF summarizes its valueproposition as follows: “The Emergency LiquidityFacility (ELF) is a Fund located in San Jose, CostaRica with operations throughout Latin America and theCaribbean. ELF has more than US$ 10 millionavailable to assist in emergencies. ELF was createdwith the participation of bilateral and multilateralinstitutions, as well as private investors. ELF’s purposeis to serve as a lender of last resort to microfinanceinstitutions (MFIs) affected by natural disasters or man-made crisis”.http://www.emergencyliquidityfacility.com/index_eng.php.

52 Details about ProFund’s individual investments and itsoverall portfolio composition can be found athttp://www.ProFundinternacional.com/.

53 Silva, Alex. “Investing in Microfinance: ProFund’sStory.” Small Enterprise Development Journal. Vol. 16,No. 1. March 2005.

54 “The Hidden Wealth of the Poor: A Survey ofMicrofinance.” The Economist. 5 November 2005.

55 This information came out of a personal conversationwith Alex Silva.

56 Silva, Alex. “Investing for Profit in Micro and SmallBusinesses: The ProFund Experience.” Office ofDevelopment Studies, Bureau for Development Policy,United Nations Development Programme. Undateddraft. www.undp.org/ods/areas/area-3/area-mm/Silva5fin.doc.

57 Ibid.58 Recognizing that MFI managers have few financing

options for such management buy-outs, Omtrix haslaunched the Antares Fund, which will help providecapital for such transactions.

59 Rhyne, Elisabeth. “Perspectives from the Council onMicrofinance Equity Funds.” Small EnterpriseDevelopment Journal. Vol. 16, No. 1. March 2005.

60 This case study draws significantly on conversationswith Vineet Rai, CEO of Aavishkaar India MicroVenture Capital.

Endnotes


61 Aavishaar India Micro Venture Capital Fund.“Aavishkaar Funds Two Path-Breaking Projects.” PressRelease dated 6 May 2003.

62 Nageswaran, V. Anantha. “Investing for SustainableGrowth: The Aavishkaar Experiment for SustainableFinancing”. Paper presented at the University ofGeneva. 5 September 2003.

63 This case study draws significantly on conversationswith Jan Piercy, Executive Vice-President ShoreBankCorporation, and with Paul Christensen, President andCOO of ShoreCap Management.

64 This case study draws significantly on conversationswith: Gillian Arthur, Operations Head of Actis;Jonathan Bond, Managing Partner of Actis; andAmber Nystrom, Executive Director of Social Fusion.

65 Social Fusion is a San Francisco, California-basedincubator of social entrepreneurs and venturesworking in emerging markets. More information aboutSocial Fusion can be found athttp://www.socialfusion.org.

66 SustainAbility, International Finance Corporation andEthos Institute. “Developing Value: The Business Casefor Sustainability in Developing Markets". London:Sustainability, 2002.http://www.sustainability.com/downloads_public/insight_reports/dev_value.pdf.

67 Social Fusion introduces the roundtable events asfollows: “The primary focus for this series of invitationalinvestor roundtables is to consider exceptional equityinvestment opportunities in emerging markets. Invitedparticipants include individual and institutionalinvestors who are decision makers interested inconsidering emerging market investment as a financialstrategy; and as a means to build sustainable, positiveimpact on a global scale. Specifically, our goals foreach session are to: build targeted market feedbackabout equity investing in emerging markets,strengthen relationships and engagement betweenkey investors, financial intermediaries and institutionsto promote market development and more efficientcapital flow, and produce increased investments andcapital flow into emerging markets.” Social Fusion.

68 Like many private equity funds, Actis has a substantialminimum investment. For the funds it was raising inlate 2005, the minimum investment was US$ 5 million.

69 http://www.vantagep.org/70 http://www.endeavor.org/71 For additional information on Unified Investment

Strategies, please see The Investors' Toolkit, by thisauthor, et al, at www.blendedvalue.org and review theinformation on the Heron Foundation’s website,http://www.fbheron.org/

72 Jacqueline Novogratz. “Creating InvestmentPortfolios”. Alliance Magazine. Vol. 8, No. 2. June2003.

73 Acumen Fund.http://www.acumenfund.org/Work/Metrics. December2005.

74 Ibid.75 Jackie Khor, ProVenEx Associate Director.

“Background Information” presentation dated May2005.

76 “The Hidden Wealth of the Poor: A Survey ofMicrofinance.” The Economist. 5 November 2005.

77 Abrams, Julie and Gautam Ivatury. “The Market forForeign Investment in Microfinance: Opportunities andChallenges. CGAP Focus Note. No. 30. August 2005.

78 Microvest serves as a financial intermediary for MFIs. Itmanages a fund that invests in MFIs by means ofdebt, equity and other similar investment structures.More information can be found athttp://www.microvestfund.com/index.html.

79 SHARE MICROFIN LIMITED. Annual Report, 2001.80 Ibid.81 Hewlett-Packard. “Remote Transaction System:

Solution Brief.” http://www.hp.com/e-inclusion/en/project/microfinanceweb.pdf. 2005.

82 Ibid.83 The Rating Fund. “Completed Rating Reports.”

http://www.ratingfund.org/ratings_completed.aspx.December 2005.

84 The Rating Fund. “Rating and Assessment Agencies.http://www.ratingfund.org/rater_compare.aspx.December 2005.

85 Microfinance Information eXchange.http://www.themix.org/en/index.html. December 2005.

86 The MIX Market.http://www.mixmarket.org/en/home_page.asp.December 2005.

87 The MicroBanking Bulletin.http://www.mixmbb.org/en/index.html. December2005.

88 The Global Development Research Center. “RatingStandards and Certification.”http://www.gdrc.org/icm/rating/. December 2005.

89 Tulchin, Drew and Mkund Bhaskar. “PositioningMicrofinance Institutions for the Capital Markets.”Social Enterprise Associates Working Paper #5. SocialEnterprise Associates. 2004.http://www.socialenterprise.net/pdfs/Position_MFI_Cap_mkts_05.pdf.

Endnotes

The World Economic Forum is an independentinternational organization committed to improvingthe state of the world by engaging leaders inpartnerships to shape global, regional andindustry agendas.

Incorporated as a foundation in 1971, and basedin Geneva, Switzerland, the World EconomicForum is impartial and not-for-profit; it is tied tono political, partisan or national interests.(www.weforum.org)

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Blended Value Investing