• A study conducted by Invest in Visions confirms Microfinance resiliency to economic cycles and market disruptions.
• Increased diversification potential and improved risk-return ratio with microfinance.
Microfinance funds are assumed to being suitable for diversifying a portfolio because of the non-correlation to traditional asset classes and thus the asset class reduces the overall portfolio risk. In collaboration with the Technical University of Cologne (Technische Hochschule Köln), Invest in Visions has analysed the diversification effects of the microfinance asset class over an 18-year period.
The result: microfinance has the potential to improve the risk-return ratio of a classic mixed asset portfolio, but contemporary trends are emerging with regards to the direction and strength of the correlation and investors need to differentiate the proportion of microfinance in the portfolio more diligently, especially in times of (financial) crisis.
An asset class in turbulent times
As an impact investing product, microfinance claims to achieve social impact next to financial performance. In a recently published white paper “diversification effects of microfinance investment”, the authors analyse the scientific debate of the poverty-reducing effect of microloans and the historical diversification effects. Most macroeconomic studies published in the past have already shown a clear link between the spread of microfinance and a reduction in poverty and income inequality.
The results of the analyses on diversification effects and portfolio optimisation are far more exciting: the correlation analyses of all indices were examined over the course of 18 years and over three 6-year periods. Older studies were regularly limited in their information value due to shorter time periods or a small number of microfinance funds analysed.
The results reveal some surprising findings: negative correlations became weaker and positive correlations stronger with each period. The Symbiotics Microfinance Index (SMX) as benchmark for the asset class was compared with bond, equity, money, and crypto markets. In addition, a distinction was made between traditional and sustainability-oriented indices (naturally, the observation period for crypto index and all sustainability-oriented investments was shorter than 18 years).
Noticeable is a positive correlation in fixed income while the traditional equity markets show no statistically significant correlation. The correlation between microfinance and bond markets becomes increasingly stronger over time. Equally striking is the development of the correlation coefficient. For example, the coefficient of the MSCI Emerging Market Index was -.345 in the first six-year period, -.189 in the second period and then a remarkable +.127 in the third six-year period. This shows by way of example that the diversification potential of microfinance can also fluctuate considerably.
Edda Schröder, Founder and Managing Director of Invest in Visions, explains: “The asset class microfinance can generally be suitable for portfolio diversification, as this asset class tends to be resilient to economic cycles and market disruptions. However, you should also diversify and invest globally.”
The analysis also examined correlation behaviour in times of crisis when diversification potential is most important. The behaviour was analysed during a) the monetary crisis of 2010, b) during the pandemic, c) the start of the Russia-Ukraine conflict and d) in crisis year 2015. Even during the peak phases of each respective crisis, microfinance yields did not rise above the +/- 1% mark. This illustrates how low the volatility of the microfinance sector is, particularly in volatile capital markets. However, the number of significantly strongly positively correlated indices doubled during the coronavirus crisis year 2020 compared to the same period in the previous year. According to the study, if such shifts towards positive correlation were to occur, particularly during crises, this would significantly reduce the risk reduction effect. The constant returns of microfinance would then no longer serve as a counterbalance to the falling prices of the other markets to the same extent.
Microfinance in the portfolio reduces overall risk.
Finally, to assess the diversification potential, portfolios with different target values were constructed and compared for traditional, sustainability-orientated microfinance investments.
The empirical analyses show that in an equally weighted portfolio of different asset classes, the standard deviation of returns decreases as the microfinance share increases. This is due to the low correlation of the SMX with the other indices, which fluctuates significantly less around its mean value than the benchmark indices over the entire observation period (shortened period for sustainable and crypto indices). Microfinance can therefore reduce the overall risk regardless of the weighting. At the same time, greater diversification benefits can be achieved than with comparable equity and bond indices from the sustainability sector.
The study makes it clear that microfinance still has the potential to diversify a portfolio of traditional asset classes and significantly reduce risk. At the same time, however, sustainability-oriented investors must also expect a drop in returns if they integrate microfinance into their portfolio.
“For risk-averse investors in particular, microfinance is therefore an attractive investment that can increase the efficiency of the portfolio, even apart from the social return,” says Schröder.
The full study can be downloaded here: https://www.investinvisions.com/en/blog/press-releases/diversification-effects-of-microfinance-investments/
