Impact of Microfinance and Poverty Traps

Impact Investing Session 1

• Impact Investing (7.170), Fall Term 2024, University of St. Gallen, taught by Prof. Julian Kölbel
• Course session focused on defining impact
• Impact is the change in a parameter Y caused by activity X
• Three key ingredients of impact:
  • Parameter Y (what you want to change)
  • Action X (what you take)
  • A claim that X causes a change in Y (model or theory of change)
• Impact is the difference between what happened due to activity and what would have happened without.
• Defining impact requires understanding the relationship between cause and effect and avoiding correlation.

Investor Impact

• Investor impact is the change in company impact caused by investment activities
• Company impact is the change in the world caused by company activities
• Mechanisms of investor impact, including enabling growth, encouraging improvement, and influencing the public discourse.
• Learning goals of the session include defining impact in the context of investing, comparing and contrasting mechanisms of investor impact, and qualitatively assessing impact on concrete investment products.
• Three primary motivations for sustainable investing: avoiding profit from environmentally damaging activities, helping fight climate change, and recognizing better returns from investments that prioritize climate security.

Key Concept #3

• Investors can either grow companies with positive impact (green companies) or improve companies with less positive impacts (brown companies)
• Green companies: Already have a good impact, but need external funding to facilitate growth (small and young companies, or companies with intangible assets, or companies in immature financial markets).
• Brown companies: Have room for improvement and can still be positively impacted despite any negative impact already occurring (large, existing companies also included).

Microfinance and Experiments (Session 2)

• Course session covered the microfinance market overview, theory of change of microfinance, and experimental results.
• Objectives were to get an overview, understand the theory, and evaluate the experimental results.
• Traditional banks rely on physical collateral.
• Microfinance institutions rely on trust and social collateral.
• Primary strategies for microfinance include:
  • Group liability
  • Assortative matching
  • Peer monitoring
  • Dynamic incentives
  • Social collateral
• Key focus is on women as they have limited access to traditional financial services and often use loans to support their families.
• Microfinance's theory of change includes capital (input), action (lending without collateral) leads to business investment (output), leading to increased sales and profits (outcomes), leading to long-term increases in household income (impact).
• Adverse selection in trading banking leads to restricting credit to risky borrowers; Moral Hazard is when borrowers take riskier actions after getting loans; lack of credit history or collateral is a constraint in developing regions, especially in developing regions.
• Mohammad Yunus pioneered microfinance, founding Grameen Bank in Bangladesh.
• Saving groups - common practice in many countries, focusing on shared contributions, mutual support, and social funds.
• Current microfinance practices in rural Malawi are an example.
• Microfinance, in practice, uses village selection based on criteria and community integration based on delivering a specific mission to each community.
• Microfinance encourages repayment discipline using group formation and training programs combined with village centers for transactions and community gatherings.
• Forms of financial inclusion, beyond microfinance, focus on expanding access to credit, savings, insurance, and digital payment services, while considering financial literacy for all.
• Ex-ante theory of change includes input (capital), activity (lending without collateral), output (business investment), outcome (increased sales/profits), and impact (increase in household income).
• Poverty trap generalized: situations where income repeatedly reverts to a lower level, which can stem from insufficient investment in technology, lack of food security to sustain productivity, and lack of access to healthcare or employment opportunities. The poverty trap's illustration is a graph.

Shareholder Engagement and Matching (Session 3)

• Learned about shareholder engagement strategies and interpretations of matching studies.
• Exit, Voice, and Loyalty by Albert O. Hirschmann, 1970 – Two fundamental responses to organizational decline, with three possible outcomes: exit, voice, or loyalty. General considerations about exit/re-entry, cost of voice, and combinations of voice/exit are covered in this theory, which is applied to emigration, employment, and schools.
• Examples of successful shareholder engagement, like Hermes engaging Sinopec on climate change.
• Discussion of requirements and limitations of shareholder engagement, including focusing on meaningful, low-cost, and easily achievable improvements or improvements that require substantial/transformational effort and broader investor influence.
• Typical asset classes for this mechanism are public markets (e.g. public markets: public equity and public debt).
• The Climate Action 100+ initiative and a case study of LafargeHolcim's Science-Based Climate Target.
• The guide covered democratizing shareholder voting, highlighted digital tools for retail investors to increase shareholder democracy and participation.
• The matching method, an approach for drawing valid conclusions from studies to find the causality between the treatment and outcome, focusing on the criteria being truly attributable to the success or failure.
• The process of drawing valid conclusions in matching studies - focus on controlling for confounders, such as size of firm involved, industry, and country.

Private Equity and the Additionality of Capital (Session 4)

• Concepts of adequate capital investment and the limiting factor of an investment.
• Illustrative example regarding the success potential of alternative protein.
• Discussion of the success of Planted Foods and how much of that success was due to impact investors.
• Discussion of the private investment fund Blue Horizon and its investments by industry and year.
• Discussion of investor impact in terms of avoiding or accelerating mission drift for start-ups.
• Discussion of measuring investor impact and what constitutes a measurable impact (accounting standards).
• Discussion on a potential framework for measuring and evaluating impact.
• Discussion on the role of second-order effects (e.g., encouraging entrepreneurship in un- or underdeveloped markets).

Special Instruments (Session 5)

• Green Bonds - issuance per year and worldwide issuer distribution by sector are covered. Example: Ford Motor USD 2.5bn green bond.
• Sustainability-Linked Bonds (SLBs) - described as a type of bond where a predetermined sustainability performance is linked to a specific metric (e.g., CO2 emission level). The coupon payment details (step-up, or step-down) are discussed based on whether the performance conditions are met or not. Also, the example of Holcim is covered.
• Litigation Finance - explained as a form of investing where investors provide funds to a claimant in a legal case.
• Blended Finance - explained with the illustration of a simplified capital structure and the example of the Allianz SDG Loan Fund covering alternative investment fund managers (AllianzGI).

Explore the intricacies of poverty traps and the role of microfinance in alleviating poverty. This quiz covers key concepts such as challenges faced by marginalized groups, the impact of investment strategies, and the effectiveness of microfinance interventions. Test your understanding of these critical issues in economic development.