Krauss, Nicolas and Ingo Walter. "Can Microfinance Reduce Portfolio Volatility?" Working Paper, New York University, November 2006.

This paper is the first we have seen of the risk characteristics of microfinance investment vehicles (MFIs). It presents evidence that these vehicles had low correlation with the broader market over the 1998-2004 time period, and that including them in investment portfolios may therefore reduce overall portfolio volatility.

The study reviews data on 283 MFIs with audited financial statements from the MixMarket database, and compares it with publicly available data from commercial banks. Data on the S&P 500, MSCI World equities and MSCI Emerging Markets equities indexes were taken from Bloomberg.

Of three potential ways to measure beta - historical market beta, fundamental beta, and accounting beta, only the last is practical for microfinance vehicles, as these investments are not continually priced in markets, and, as an emerging asset class, have no appropriate peer group.

Using a regression model, the study shows that "MFIs...do not show significant correlation with the S&P 50 index with regard to their operating fundamentals - ROE, profit margin, total asset growth, loan portfolio growth, and asset quality. All r2 values are extremely low, although the "real" values should be higher due to the use of accounting data."

This leads the authors to conclude that "the preliminary empirical evidence suggests that MFIs are to a significant extent detached from major markets and from domestic macroeconomic conditions that affect the performance of conventional banks." They attribute the differences in market risk to differences in ownership and governance, client and product characteristics, lending methodologies, and to lower operational and financial leverage.