Responsible Investing: Shariah-compliant microfinance investment fund eyeing Asean opportunities

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on September 25, 2017 - October 01, 2017.
I view the growth in the popularity of investing in microfinance as being driven by the capital markets responding to this demand, as well as a cultural and value shift among investors who are adding a social component to their investment philosophy. > Martin

I view the growth in the popularity of investing in microfinance as being driven by the capital markets responding to this demand, as well as a cultural and value shift among investors who are adding a social component to their investment philosophy. > Martin

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Investing in microfinance institutions (MFIs) has become increasingly popular in the last decade. This option, often included under impact investing, allows investors to earn returns while providing small merchants with financial assistance.

According to a 2016 Consultative Group to Assist the Poor (CGAP) report, global microfinance investment vehicles (MIVs), or microfinance funds, have seen capital inflows of US$1.1 billion per year since 2006. The market size at end-2015 was US$11 billion — a fivefold increase from US$2.1 billion in 2006. 

There are two reasons for the trend, says Matthew Martin, founder of microfinance investment fund Blossom Finance. One is the rising desire among investors to do social good; another is the increasing popularity of MFIs — and their need for funding.

“A massive portion of the world’s population is still unbanked or underbanked and microfinance is one of the best tools to provide financial services to underserved segments. Despite some great successes in microfinance, the overall sector still suffers from a perennial lack of capital. The current microfinance volumes could easily grow 100 or 1,000 times and still not meet the overall demand,” says Martin.

“I view the growth in the popularity of investing in microfinance as being driven by the capital markets responding to this demand, as well as a cultural and value shift among investors who are adding a social component to their investment philosophy.”

While MIVs usually target countries in Eastern Europe, Central Asia, Latin America and the Caribbean, the CGAP report points out that Asia has witnessed the largest growth in MIV allocation, signalling rising interest in such investments in the region.

Martin moved Blossom Finance from California to Indonesia in 2015, after observing the demand for MFIs in the country. “In Indonesia, there is a massive unbanked population and the retail banking sector has demonstrated both a lack of interest and an inability to offer suitable financial products for that population. The country is highly geographically, ethnically and linguistically diverse, with at least 17,000 inhabited islands and 300 major languages. The top-down, one-size-fits-all model of retail banking is not an ideal fit,” he says.

Martin points out that microfinance can better serve the needs of such communities. “With microfinance, an independent network of institutions can bring its regional and local knowledge and expertise to bear. That is really effective in terms of reducing underwriting risk. 

“Indonesia is a highly community-oriented society and ‘social collateral’ is a really effective way of mitigating underwriting risk. Members of an existing community can effectively leverage social collateral within a community, whereas a monolithic retail bank cannot.”

US investors, on the other hand, can benefit from investing in MFIs in Southeast Asia. “American investors, in particular, have a lot to gain from diversifying into emerging economies such as Indonesia. They have lived through more than 1½ decades of anaemic interest rates — for example, five-year yields on certificates of deposit have not even broken through 4% since 2002,” says Martin.

“And they have lived through a huge recession caused by massive fraud and malinvestment by the biggest financial institutions in the US. Having lived through this, US retail banks are just not an attractive place to put your money to grow your wealth. This is especially true today, given all the tech-based alternatives to conventional investments.

“In terms of Southeast Asia specifically, investors recognise this is a hotbed of growth. American venture capitalist Tim Draper recently announced that he would be focusing on Indonesia rather than China.”

Three years ago, there was a lot of fear and uncertainty among US investors regarding this investment opportunity, he says. But now, they have a much higher level of confidence as they are more familiar with the model.

“They are getting into something highly diversified from everything else such as unit trust funds and the stock market. It is very unlikely that Silicon Valley macro trends, for example, will impact market vendors in Indonesia. Americans also like doing social good,” says Martin.

The fund is currently limited to US accredited investors due to legal and compliance issues, but Martin hopes to open it up to investors from other parts of the world soon. “In the future, we would like to allow anyone to invest in this because we think it is a great opportunity not just to make a commercial return on your money but also to do something good with it — helping a farmer or business generate liveable income. We think it is something you can feel good about while making money, so that is a dual mission,” he says.

As Martin is a Muslim, Blossom Finance only invests in shariah-compliant MFIs — catering for the demand in Indonesia, home to the world’s largest Muslim population. “Blossom Finance is focused on providing financial services to the working poor. We do that by taking international capital and investing in MFIs that are specifically focused on Indonesia. The system we use is a shariah-compliant model, which is what we believe to be a more socially responsible model than the conventional loan-based finance,” he says.



Blossom Finance works with five MFIs that provide loans primarily to market vendors and micro-entrepreneurs in Indonesia. As these lenders serve a large number of clients, the risk for investors is lower if a borrower defaults, says Martin.

“If you invest in Blossom Finance, your risk is spread out across thousands of enterprises. So, even if a bunch of enterprises lose all of their money, it does not leave much risk on your portfolio,” he says.

MFIs came under the spotlight in 2006 after Muhammad Yunus and Grameen Bank — an MFI in Bangladesh — won the Nobel Peace Prize for providing microloans to the poor who would otherwise find it hard to obtain loans from traditional banks. Most of the loans went to women and the repayment rate was high.

Grameen Bank inspired the establishment of similar institutions in many countries. Funds targeting MFIs began to emerge, although some institutions raised so much funds that they drew criticism for their effectiveness, such as India’s SKS Microfinance and Mexico’s Banco Compartomos.

Martin says MIVs such as Blossom Finance can help investors identify the right MFIs. “We typically only consider MFIs that have already been operating for three years. We like to see that they have done a certain volume of financing in the past, as well as heavy community participation. 

“MFIs also provide savings products, so we like to see a high degree of activity within the community on the saving side because that shows us that the community trusts them. We typically like MFIs that also provide education and support services.”

The MFIs operate on a social collateral model, which Martin says fits a very community-centric society such as Indonesia. The MFIs have to interview an individual’s relatives and friends to determine whether or not to extend a loan to that person.

“The MFIs are embedded within communities, so the beneficiaries are actually well known to the members of the institutions. They are well-known members of the community and their creditworthiness is based on their reputation. Indonesia is a very family and community-oriented society and one’s reputation within society is paramount,” says Martin.

The staff of the MFIs also visit borrowers on a daily basis so they can provide assistance to those who are struggling, he adds. “Typically, it is a daily repayment cycle. So, the MFIs are very engaged with the entrepreneurs. They know ahead of time if the entrepreneurs will run into trouble because they missed their daily payment.”

Since many of the MFIs are embedded in rural communities, many of the staff are not comfortable with English, says Martin. Blossom Finance’s role is to help get the story of their impact out to international investors so they can understand how their money is used.

“This is where Blossom Finance is adding value to the MFIs — by taking care of the investor side, communicating with international investors in the appropriate language, packaging the investment in a way that international investors are comfortable with and handling things such as tax treaties between the US and Indonesia. Telling the story to a non-Indonesian audience is very important to getting investors to come in and invest,” he says.

Once Blossom Finance has identified the MFIs, it channels the funds and sometimes sets conditions such as allocating a certain amount of money to female or young entrepreneurs. The investors on its platform can choose the categories — gender, occupation or region — they are interested in.



Martin established Blossom Finance after he converted to Islam in the US after a thorough research of the religion. But as an entrepreneur, he could not find shariah-compliant financial platforms in the country. This gave him the idea to increase the number of shariah-based financial products.

“In shariah compliance, there are a couple of things you cannot do: You cannot have a loan that has any increase over the principal capital, or in other words, a fixed rate of return on a loan. Also, you cannot have a contract that has excessive uncertainty or engage in businesses that are harmful to society such as pornography, weapons and predatory lending practices,” says Martin.

Blossom Finance’s system is based on two Islamic principles, one of which is mudarabah, or a profit-sharing contract. “It means silent partnership, where the investors act as our silent partners — they give us capital and we act as entrepreneurs investing the capital on their behalf. What we take from them is a share of the profit. When the money comes back — if there is a profit — we take a percentage of the profit based on the contract we have with them,” says Martin. 

Blossom Finance currently takes 20% of the profit. The same principle is used in its relationship with the MFIs, which in this case, act as the entrepreneurs and figure out who to give the money to. The percentage that it takes from this relationship varies, depending on the MFI. It is typically a 50:50 or 70:30 profit-sharing model with the MFIs, in which Blossom Finance has the higher stake.

The second Islamic principle it uses is murabahah, or a sales contract that discloses the asset’s cost price and profit margin. “It means asset cost plus asset purchase. It comes from the old days when if there was someone old who could not leave the house, or if there was someone without much knowledge of a specific commodity, he could hire someone knowledgeable to go to the market on his behalf and buy that product. Then, he will give that person a percentage of the price of the commodity,” Martin explains.

The same structure is used between the MFI and the borrowers, although the profit margin depends on the size of the MFI, repayment agreement with the borrower, amount of money borrowed and how long the business has been operating.

Another feature of this model is that the borrowers do not have to put up anything as collateral as they do in the traditional lending model. “It is not debt. There is an obligation for the entrepreneur to repay the money, but if the business does not work, there is no personal debt,” says Martin.

“A lot of microfinance based on the traditional lending model ends up becoming a personal loan. And when the business fails, they end up paying the loan, which we feel is kind of a predatory model and not really suitable for the working poor. The last thing you want to do is take someone poor with zero debt and turn them into someone poor but with debt.”

According to previous reports, Blossom Finance’s investors can expect an 8% to 12% return on investment. But Martin says he wants to bring the figure down so that the fund can focus less on reaping returns and more on directing resources to the micro-entrepreneurs it hopes to help.

“We want to weigh more heavily on the social good aspect because some of our initial returns were very high. But the end result of that is the cost of capital is also very high for the entrepreneurs,” he says.

“In that case, there are only two things you can do — charge the entrepreneurs more or give the investors less. In terms of returns, we are just trying to find the right balance. So, we have brought that number down for some of our subsequent funds.” 

The microfinance investment fund is looking at a more realistic figure of 8%, he adds.

Martin says Blossom Finance’s priority is to open up the fund to retail and international investors. “The outlook is very bright. The number of qualified beneficiaries is increasing. I see Asean as a source of capital rather than focusing on the US and other developed markets. I see this mode of financing as completely leapfrogging the conventional banking models and it will be a future trend.”