“Microfinance Irrigators should not put all their pumps in the same place”- BlueOrchard

Microfinance Focus, July 14, 2010: BlueOrchard a group of commercial microfinance investment companies based in Geneva – Switzerland manages over $1 billion of assets with investments spanning over 40 emerging markets and 150 Microfinance banks. It is made up of two companies: BlueOrchard Finance S.A. which since 2001 has provided credit to microfinance institutions (MFIs), and BlueOrchard Investments Sàrl which since 2007 has invested in the equity of MFIs and network funds. The first BlueOrchard Private Equity Fund managed by BlueOrchard Investments has just closed and attracted $200 million, making it the largest single Private Equity Fund of the industry.

Jean-Pierre Klumpp, CEO, BlueOrchard

In an exclusive interview with Microfinance Focus, Jean-Pierre Klumpp, BlueOrchard Finance S.A. – Chief Executive Officer discussed the current microfinance investment market in India and the future roadmap for BlueOrchard in the country. Here are the excerpts from the interview. 

Microfinance Focus: As a leading investor, what is your perception of the Indian Microfinance market in general?

Jean-Pierre Klumpp: It is a fascinating market because of its size and is in many respects a world in its own.  Traditionally the markets where we invest are in need of external financial help but in India the situation is somewhat different.  Here the “Top of the pyramid” is world class, impressive in many respects and a challenge for developed economies; but at the same time there is a huge “Base of the pyramid”. We therefore think that we can contribute in various ways to the immense task of providing access to financial services to these several hundreds of millions of people.  We are convinced that the efficiency and the sustainability that profitability brings in are important factors for reaching the necessary scale, thus performance is required at all levels from the micro-borrower, the MFI to the Investment fund.

Microfinance Focus: How do you define double bottom line investment?

 Jean-Pierre Klumpp: Our microfinance investment products provide investors with both a financial return and a social impact. We have a very strong relationship with broad investors groups, these being private and institutional and the vast majority care about the social impact of microfinance. For some it is the decisive factor for participating, for others it comes on top of the financial return of this different asset class. For example Pension Funds have certain performance requirements and sometimes in low rates environment microfinance debt products come close to their minimums. Therefore they insist on having evidence of the contribution of microfinance to sustainable development worldwide. That’s why they are asking us as to how we assess impact and we have developed as a part of our due diligence, a component on social dimension, that we factor in before we make any investment or before we provide funding.

 We are asking MFIs about their declared social mission but we certainly believe in the merit of scalability, solid performance and a drive which you can only achieve if you are commercially organized. But we would not want certain investment partners to, for instance diverge to consumer lending because there would be higher margins or short term higher returns. We understand there is a demand in certain market for consumer lending and it can become part of the offering but not the overweight. The reason why we are investing is that we are clearly dedicated to an industry that has both a social and a sustainable developmental dimension and we are positioned at the more dynamic/commercial end of it.

Microfinance Focus:  Are there any recent changes in your global investment strategies?

Jean-Pierre Klumpp:  From a global microfinance perspective we all agree that the world financial crisis has highlighted industry specific crisis elements like over borrowing and over indebtedness, very unfortunate negative side-effects that have resulted from the incredible speed of growth in recent years.  We believed because of the overall size of the worldwide unmet demand that it was essentially a “downhill race” for scale, but with limited control mechanisms built in. Today we have learned much and understand the need for systemic capacity management. Asset Managers have a role to play in this and we need to rebalance our portfolios according to real demand and not simply go where it seems to be the easiest. In addition workout and default situations have materialized, as one would expect in a mature asset class, so that today the race appears more like uphill and curvy, thus more selective.  BlueOrchard is prepared for this.

For quite some time we have become bullish on India. What attract us to India is that it is an unusual combination of an investment grade country that has great capability but never the less huge amount of needs is still present in the microfinance sector. From a “top-down” investment point of view we don’t think there are substantial risks and it is impressive how India weathered the global financial crisis. In many smaller countries where we invest adverse situations can rapidly have major consequences, e.g. nobody anticipated that the situation in Kyrgyzstan could deteriorate so much  over a weekend. Obviously we don’t think that it can happen that way in India.

 Microfinance Focus: In India a lot of discussion around valuation and growth is happening. What is your view on these two debatable issues?

Jean-Pierre Klumpp: What I like most is the debate because at this point there are few transactions. Considering the size of the unmet demand there will be a continuous need for equity simply to fuel the growth.  Attracting the right kind of investors will be a key success factor. Since there are few microfinance private equity funds that have closed yet it is important to have an educated debate, e.g. about the future possible exit strategies. Current discussions, e.g. around IPOs are very important and need to assess all aspects considering that microfinance is part of sustainable and socially responsible investments.

Of course private equity investors make a major effort upfront when investing in microfinance but future performance will also depend much on their added value along the road, e.g. creativity regarding product offering, cleverness of operating models, anything that will make it more compelling for the market or whoever will buy it.  I think it is good to get inspiration from the regular financial industry but keeping in mind that sometimes it is not totally appropriate considering the social dimension.

With respect to the growth issue, again it is a question of capacity management and how to master distribution. It is like a financial desert and India still has big dry parts and you have to make sure that when you start irrigating you don’t put all your pumps at the same place and if you can somewhat organize it this might allow for deployment where it is required. But the reality is that everyone tries obviously to go where it is the easiest, so at times several players come to the same places. Of course competition will have various benefits but “over-irrigation” must be prevented since it can harm a lot the young and still fragile business seeds. Credit bureaus can definitely serve as safety mechanism. Of course over-indebtedness is self curing since if borrowers do not repay, institutions over time will start losing money and thus becoming less attractive. Control mechanisms like credit bureau must be build in since over-indebted micro-borrower as the weakest economic link in the chain will be impacted first and most.  The industry has an opportunity to demonstrate its leadership by contributing to this important part of the client servicing infrastructure.

It is important to differentiate “horizontal” growth that increases the outreach to new regions and or customer segments and that can be very fast from ”vertical” growth that increases the amount made available to existing micro-borrowers and that must remain synchronized with the development dynamics both at the individual and collective level.  During fast growth the challenge is to really identify the main growth drivers, which is probably also the case today in India.  

Probably it will lead like in every market to some “bubbling” before various elements of systemic regulation come to play. Sometimes some “bursting” is even required before broad band measures are taken. I am sure this topic being so widely discussed presently in the industry and in the press will foster adequate measures if any are required, thus preventing adverse impacts. You cannot be only a good weather captain you also have to be prepared for bad weather and this will certainly help differentiate between the various MFI players. Do they have the expertise and the strengths in managing the hard times to compensate for the lack of experience since most resources are home grown and probably have never really been confronted with adverse situations. So I think smart and successful MFIs will cross train, manage to attract people from the mainstream who have been once exposed to challenges and therefore be well prepared.

 Microfinance Focus: What is the roadmap for BlueOrchard in India?

Jean-Pierre Klumpp: In India we are exploring on the Debt side, the Foreign Institutional Investment (FII) route. We are in the process of considering this status since it will allow for the purchase of NCDs (Non-Convertible Debentures). We are looking at this as a good evolution as our top down allocation to India is important. It is roughly 10 percent in our main global funds, a maximum if you want to preserve adequate diversification. But given the market potential on one side, the country’s favourable outlook and the fact that we have various routes available including local currency capability, for us it is clearly a “go” territory. But we must find appropriate partners and to date we have worked successfully with Citi and Standard Chartered Bank where we have engineered our ‘passage to India’. FII status besides NCDs could lead as well to other interesting schemes in the future and because of our long term ambitions in the region we might consider at some point an NBFC structure, catering for both international and local investors, with a blend of debt and equity.

 We have done Collateralized Debt Obligation (CDOs) in the past. It is not a popular structure anymore nowadays because of its association with the recent market collapse but we think that structured finance remains interesting for microfinance investing since it can assemble investors with different risk/return profiles and social motivations. BlueOrchard has the ability to be competitive and attractive at the institutional level. We can meet the financing need of a broad range of MFIs from the top institutions to more niche players. We are also considering to invest in tier two and tier three MFIs as well as in more frontier markets . We are finding matching investors for our microfinance schemes. While seeking performance in all what we do, we remain very dedicated to microfinance and we continuously look for initiatives and areas where our contributions can make a positive difference for all stakeholders.

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