9 May 2005, Business Week

With about $200 of his own money and a $1,500 loan, Vahid Hujdur rented space in the old section of Sarajevo and started repairing, then reselling discarded industrial sewing machines. Eight years and several loans later, Hujdur now has 10 employees building, installing, and fixing industrial machinery.

Hujdur didn’t get his initial loan from a local bank. “They were asking for guarantees that were impossible to get,” he recalls. Instead, the capital came from LOKmicro, a local financial institution specializing in microfinance — the lending of small amounts to the poor in developing nations to help them launch small enterprises.

Microfinance institutions (MFIS) such as LOKmicro get capital from individual and institutional investors in the U.S. and Europe via microfinance funds. Groups that run the funds collect the money, vet the lenders, offer them management assistance, and administer investors’ accounts. In the vast world of global finance, microfinance is, well, microscopic. But it is growing. The microfinance Information eXchange, an industry tracking group, says its universe of 60 leading microfinance institutions lent $3.1 billion to poor borrowers in 2003, the latest available figures. That’s more than twice the $1.4 billion loaned in 2000. But because the loans are small, sometimes $50 or $100, the money goes far. Microcredit Summit Campaign, another microfinance watcher, says the 779 MFIs in its database serve about 81 million customers in Latin America, Eastern Europe, Africa, and Asia. Loans are made for a variety of purposes: manufacturing, transportation, agriculture, and retailing.

The borrowers pay relatively high interest rates, perhaps 20% to 30% on an annualized basis. Why so much? Lenders say the cost of writing and administering such small loans is high. And since the MFIs operate in nations with weak currencies, they need to charge more to make sure there’s enough to pay back investors who lent them dollars or euros. The rates may not seem onerous to borrowers when their only other source of credit is a loan shark.

Default rates on MFI loans run about 4%, which is less than half the rate on subprime loans made by U.S. lenders. “There is a deep pride in keeping up with payments,” says Deidra Wager, 50, an executive vice-president of Starbucks (SBX ), who invested $100,000 in a microfinance equity fund in 2003. “In some instances, when an individual is behind on payments, others in the village may make up the difference.”

Nobody should invest in microfinance for the financial returns. Expect to earn perhaps 1% to 3% on debt funds, and 7% to 8% on equity funds. But that’s not the point. Through this sort of social investing, you give people a shot at self-sufficiency. “Handouts generally promote dependence, not independence,” says Mark E. Van Ness, part-owner of a commercial real estate investment firm, Sperry Van Ness in Newport Beach, Calif.

His company’s foundation invested $100,000 in the Latin America Bridge Fund in January, 2004, managed by ACCION International, one of the largest players in microfinance. The fund helps secure financing for MFIs from local banks by guaranteeing a portion of the loans. “Each dollar we give can help local organizations receive up to twice that amount in loans,” says Van Ness. “Every time the MFIs repay their loans, the fund can subsidize a new batch of loans.” His yield, only 1.5%, offsets foundation costs.

Some microfinance funds accept investments as small as $1,000 or $2,000. They’re usually just lending money, and the funds are registered with securities regulators in states in which they’re offered for sale. You still need to study the prospectus and visit the Web site to assess the manager.

Funds that make equity investments, such as ACCION Investments, may be riskier. The minimum investments are high — say $250,000 — and you may need to have $1 million in liquid net worth or as much as $300,000 in annual income. Since they’re usually private placements, there’s even less regulatory oversight. There are usually no distributions during the life of the fund, about 10 years.

For Starbucks’ Wager, a prospective 7% or 8% return was an important consideration in deciding to participate in the MicroVest I equity program. The $100,000 she put in two years ago “represents a significant portion of the assets which I can invest,” she says. “But it’s the social return that makes this a truly meaningful investment.” She spent a one-year sabbatical in Latin America seeing what microfinance means to people living on the edge of subsistence.

A major promoter of microfinance in the U.S. is the Bethesda (Md.)-based Calvert Social Investment Foundation, which manages its own programs and collects assets on behalf of other funds. The foundation takes care of administrative matters while MFIs such as ACCION, Oikocredit, Grameen, and MicroVest, in turn, manage these resources.

Kelly and Edward Simpson have invested $30,000 in Calvert Community Investment Notes. Starting with a small position in late 1998, the San Francisco couple — she’s a preschool teacher and he is a software developer — found that these notes, even when they paid 1% to 3%, have performed better than many of their stock market investments in the ensuing years. “But more important,” Kelly Simpson explains, “microfinance enables us to invest more toward helping the poor than we could possibly give.”

Indeed, investing in microfinance is like a perpetual gift. Money repaid gets recycled into new loans, giving Vahid Hujdur and millions of others a shot at moving up the economic ladder.