> Posted by Andrew Fixler, Associate, CFI

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Inclusive financial services in Africa are blooming. Between the turn of the millennium and 2011, the number of African MFIs reporting to the MIX increased from 58 to 397. From 2000 to 2014, the gross loan portfolio expanded over tenfold to $6 billion. Between 2003 and 2009, the number of borrowers served by MFIs in Africa increased from 1.6 million to 8.5 million. These numbers represent the development of an economic development tool for economies with very small financial sectors. It is impressive progress for an undeveloped industry beset by sparse human capital, problematic governance, and minimal external commercial interest.

AfriCap, which was the first private equity fund to invest exclusively in African microfinance institutions, and other microfinance investment vehicles (MIVs) funded by social investors have been a key growth factor through capitalizing MFIs and offering technical assistance and training. This interest is relatively new. The African MIV portfolio grew at an average annual rate of 36 percent between 2006 and 2013. This compares with an average growth of 38 percent for investments in the Latin America & Caribbean region since 2006, and 8 percent in both the Middle East & North Africa and South East Asia regions. The strong connection between MIV financing and microfinance sector growth was also noted in a World Bank paper, Benchmarking the Financial Performance, Growth, and Outreach of Greenfield Microfinance Institutions in Sub-Saharan Africa. The paper, released in 2014, explains the relevance of greenfield MFIs to effecting financial inclusion in undeveloped financial markets. These institutions are financed in large part by equity and debt from development finance institutions, as well as a now-significant cohort of MIVs.

African MFIs are attracting palpable interest from investors with a double bottom line. At the most recent meeting of the Financial Inclusion Equity Council (FIEC) in Zurich, social equity financers, many of whom represent the expanded cohort of Africa investors, noted that there is strong interest to invest in Africa, which is seen as ripe for social impact investment, with potentially “eye watering” multiples.

Of course, the risks vary widely by country, warranting a cautious attitude and deep consideration before money can be smartly invested (a point well noted by the FIEC meeting attendees), as shown by the cautionary lessons of some of AfriCap’s more aggressive deals. AfriCap merits recognition as a pioneering microfinance investment vehicle that helped demonstrate the dynamism and investment-worthiness of the African microfinance sector. Although fund performance did not meet the hopes of its protagonists (investors who stayed with the fund from inception until 2014 realized an internal rate of return (IRR) of 1 percent), AfriCap’s legacy as part of the “cracking” of the capital markets for the African microfinance industry is significant. AfriCap formed with a challenging mission: “to support the commercialization of the microfinance industry by bridging the transition from a sector traditionally funded by donors to a scenario where the leading MFIs were raising most of their funds from commercial sources.”

AfriCap set out to fulfill its mission by building the capacity of self-sustaining microfinance institutions. In the face of a shortage of trained finance professionals, it consciously sought to bring on and develop local management, to infuse startups and established institutions with capital, and to add value to investees through technical assistance. From its founding in 2001 through its 2014 wind-down, AfriCap made equity and debt investments in 21 African MFIs. Among AfriCap’s investments were both incredible successes and complete write-offs. Over half of all investments failed to recover their direct costs, due in part to gaps in AfriCap’s own governance mechanisms to mitigate the risks inherent in the fund’s mission. Although the ultimate IRR was relatively modest, the fund demonstrated that among the range of institutions in Africa, good investments could be found and nurtured.

A soon-to-be-released study by Grassroots Capital Management focuses on the role governance played in the AfriCap fund’s successes and failures, while recounting the fund’s many challenges and its ultimate accomplishment. The pivotal role of the board in governance, and the board’s lead responsibility for such critical matters as strategy, risk control, and management selection and succession, feature prominently in the study.

The successful investments among AfriCap’s portfolio provide a lasting testament to the potential of African MFIs, and contributed both directly and indirectly to the tenfold increase in the total African microfinance portfolio quoted above. The fund’s impact extended beyond direct effects of its investments to the signals it sent on the investment-worthiness of African microfinance markets. By investing in diverse countries, rather than only traditional targets such as Kenya, South Africa, and Nigeria, AfriCap reached beyond the “low-hanging fruit”, and demonstrated the investment-worthiness of MFIs across many countries.

Altogether, AfriCap’s results illustrate the opportunity for success in African microfinance investing. The story of AfriCap also illustrates the inherent risks of financing a diverse range of institutions, from startups to well-established companies that, when not contended with, can lead to portfolio losses.

To learn more about AfriCap’s governance challenges, and current scholarship on governance best practices, stay tuned for the Grassroots AfriCap case study to be released later this month.

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Microfinance Equity Investing: Different Context, Similar Issues

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