If you are looking for one of the very few genuine ‘high yield investment opportunities,’ you couldn’t do much better than microfinance – that is loaning money in small amounts at high interest rates to small business people in developing countries. The great thing about this investment is you can earn great returns and do good, helping entrepreneurs in the developing world, at the same time. It is something myself and a few of my clients have been investing in for several years now.It might sound risky, but there are now a number of stock-market listed companies you can invest in who do this as their primary business – and they are doing it very well.The borrowers typically have no formal credit history and have often been passed over for loans by mainstream banks, but they usually have excellent business acumen – and a way to turn a profit quickly. Many of the borrowers are women. Audited statistics show collection rates on the loans are excellent, often far exceeding those of mainstream banks. This is because micofinance works on a different, more personal basis using peer group support and credit management. Borrowers feel responsible to other people, rather than to faceless banks.Microfinance, simply the granting of small loans, has its origins in the social movement. It has long been supported by low-interest loans and subsdidies from non-governmental organisations, foundations and so on over recent years. You’ve probably heard “give a man a fish and you feed him for a day… teach him to fish and you feed him for a lifetime.”The idea of microfinance has always been that rather than helping people with short term financial aid, you can help them grow and develop their family economies so they can gradually break out of the poverty trap and move on to greater things. Often one-man businesses are able to scrape together a few bucks, but can never break out of the poverty trap because of lack of working capital. Microfinance is a way of tackling this vicious circle.The original backers of microfinance initiatives were not seeking to make a profit, so much as to do good. However, many found that the bottom line was that the microfinance institutions were generating healthy profits. A typical case of sharing Wealth wisdom – and what goes around, comes around. Helping others generate wealth can bring more wealth your way, and certainly not just in financial terms.Once traditional financiers saw that these ‘social movements’ were turning a very respectable profit, of course they wanted a slice of the action. In recent years, this has attracted more private capital to microfinance. Many venture capital firms, investors and even banks have been investing in closely held microfinance initiatives, while other microfinance institutions have floated on stock markets in order to raise equity capital.One of the leaders in this field is CompartamosBanco, a Mexican microfinance institution changed its non-profit status to become a commercial bank through an IPO worth more than a billion dollars on the Mexican stock market in 2007, after realising it could help a lot more people that way.CompartamaosBanco was incorporated in 1990, and has grown into the largest microfinance bank in Latin America serving well over 1,000,000 clients – most of them lady entrepreneurs who previously did not have access to working capital loans. Their clients use these funds to expand their businesses and invest in equipment and materials, improving the quality of life for them and their families.Is it right to Profit from the Poor?Of course, a big moral question pops up here. Is it right to profit from the poor? Perhaps more importantly, where does one draw the line between microfinance and old-fashioned loan sharking?Some of the other public faces of microfinance, such as Muhammad Yunus, Nobel preace prize winner and founder of another successful microfinancier, Graheem Bank of Pakistan, remain firmly committed to the non-profit model. They believe it is wrong to profit from lending money to the poor.Mexican CompartamosBanco, however, points out that since going public they have been able to reach out to ten times as many borrowers and lower their interest rates too. In terms of social responsibility, 60,000 of their borrowers attended free “personal finance 101″ type classes last year. If only the sub-prime lenders in the USA had been so responsible as to teach their borrowers what was really involved in the small print they were signing!High interest rates are the norm in developing countries, where the cost of managing debts is much higher than in countries with a more developed financial infrastruccture. CompartamosBanco, for example, spends $152 per year per borrower on administrating their credit portfolio, against an average loan size of $450.This is not because they are inefficient – it is simply their business model, and the way they avoid bad debts. For example, borrowers do not have bank accounts from which weekly repayments could be direct debited automatically. They are working in an informal cash economy. Bank representatives typically meet every borrower every single week to collect repayments sometimes as low as $5 each. This model works in developing countries where salaries are lower, but still results in very high management costs as a percentage of loan amounts.The result is impressive. As of June 2008 (latest statistics available), CompartamosBanco’s non-performing loans were only 1.38% of the portfolio, much lower than most traditional banks making unsecured loans to borrowers who are much better qualified according to traditional models. Non-performing credit card loans in Mexico are now running at above 10% in major card issuers such as Banamex, a subsidiary of Citibank.Since the Initial Public Offering in april 2007, Compartamos have added a new kind of responsibility to the bank’s stated goals. That is, to offer transparent and up to date information on the company, its operations and financials to its shareholders. As a result, they host market conference calls and meetings for shareholders.Shares and sharing outCompartamos says its mission remains unchanged, quotes some statistics to defend itself against the social activists who compare it to a loan-sharking outfit. Its management is convinced that by pursuing profits it will be able to provide financial services to many more poor people far more quickly than it would if it had continued to act as a charity.By charging an interest rate that generates a profit, the bank can grow fast and provide many more “micro-entrepreneurs” with the finance they need, even at interest rates that by the standards of developed countries seem unacceptably high. Compartamos also argues that its profits will build a microfinance industry. The more it earns, the more attractive microfinance will be to investors, and the more capital will flow in.The evidence tends to support this claim: since Compartamos re-launched as a profit-making entity, seven new regulated microfinance businesses have begun to compete with it in Mexico, many of them financed by profit-seeking capitalists. Greater scale and competition are driving down interest rates – in Compartamos’ case, from 115% seven years ago.”For profit” microfinance is making big inroads elsewhere too. The first for-profit (but not listed) microfinance institution, was Bolivia’s BancoSol. In India SKS, another for-profit lender created by Vikram Akula, a former McKinsey partner, is backed by Sequoia, a leading Silicon Valley venture-capital firm.CompetitionCompetition for the likes of CompartamosBanco comes in various guises. Credit Unions, for example, have been highly popular in Latin America despite their high failure rate. The main problem with credit unions is that they are not managed by professional bankers and they lack the rigid systems in place at for-profit businesses.The evidence demonstrates, however, that where there is a profit motive, things begin to look a lot better. Witness another successful non-traditional finance business in Mexico: Banco Azteca. Banco Azteca does not fit the definition of a microfinance lender, as they lend mainly for consumer purchases rather than to finance wealth-creating activities. But nonetheless, it has been very successful in what might be called ‘sub-prime’ lending – offering banking services to the unbanked who have no formal credit histories.Part of Grupo Elektra, which runs electrical goods stores all over Mexico and Central America, Banco Azteca was founded at the beginning of the twenty-first century with the aim of providing banking services to the unbanked in Grupo Elektra’s traditional markets. The Elektra stores had an existing portfolio of borrowers who had established credit records by buying electrical goods and domestic appliances and paying weekly, and it was logical to offer them banking services such as personal loans and credit cards. Since most of the customers do not have traditional bank accounts, they have to make their weekly payments in cash in the stores, or Banco Azteca sends collectors out on motorbikes all over Mexico and Central America to pick up a few pesos weekly.How to Get Started in Microfinance InvestingWhat if you decide you would like to invest a part of your portfolio in turning “poverty into profits?”Let’s start with the most conservative way – a simple bank deposit. Banco Azteca in Panama is currently paying 8% on US dollar CDs, much higher than the typical rate offered by other Panamanian banks.Another way to get started right now would be to buy shares in CompartamosBanco. It is quoted on the Mexican stock exchange and most full service brokers should be able to buy shares for you on this exchange. If not, then the brokerage house we typically work with in Panama can certainly buy them for you – in the name of a tax-free Panamanian entity of course!A more adventurous, but potentially more rewarding, way to invest would be to become a funding source for a microfinance business. This is something that would require further research on your part and good contacts in Latin America and the Caribbean, and the good thing is that the investment can be handled entirely offshore. In order to diversify risk, I would recommend doing this as a syndicate with other like-minded investors. A couple of people have already expressed to me an interest in this – so if you would like to know more, please feel free contact me via the website listed below.