Amidst reduced funding across various sectors, the financial inclusion space in 2023 has shown strength and stability. What has been your assessment of the investment trends in this space in 2023?
The financial inclusion businesses thrive on the transaction volume and growth potential of ‘Entrepreneurial Households’TM in the country, which are often outside the priorities of large banks and conventional lenders. These households are characterised by diversified and multiple income sources that fuel their economic growth aspirations and maintain resilience through multiple crises and shocks such as COVID-19. Despite the ‘funding winter’, this sector has remained relatively unaffected, especially for business models grounded in profitable distribution based on the actual needs of customers. Companies with proven unit economics and customer-aligned credit underwriting models gained increased appreciation by the world of capital in 2023 compared to preceding years. As a fund focused on high priority services, we assess household transactions to evaluate opportunities rather than capital trends.
How is investing in this sector different from others? How do you assess it in terms of return expectations, gestation periods, challenges in establishing scale, and other critical factors for an investment thesis? What should prospective investors be keeping in mind?
From an Elevar standpoint, financial inclusion or any lending business is a ‘super sector’. Its distinct advantage stems from these businesses’ capacity to diligence their customers’ before delivering appropriate products and services. This significantly deepens market understanding while expanding operations thus making returns more predictable.
Organisational success in this sector is driven by several key factors. To begin, entrepreneurs with proven leadership skills and a demonstrated execution track record are vital to creating a sustainable business model. Second, successful ventures are built on a deep customer understanding through a ‘blended intelligence’ approach from digital and physical sources. They craft contextually relevant offerings that impact customers’ cash flows and accurately address customer needs and aspirations. Finally, effective treasury and risk management practices maintain financial health and sustainability, particularly during market fluctuations.
For investors, success depends on supporting founding teams with a deep understanding of their target market and who adopt a ‘solution-oriented’ approach to customer needs. Investments may exhibit different return profiles and longer gestation periods given the need to understand customer behaviours. Establishing scale in this sector involves blending intersectional knowledge to meet customer needs. A thorough grasp of sector dynamics, leadership, customer insights, and risk management is crucial to achieving the broader goal of financial inclusion.
Over the last three years, enterprises focusing on lending to SMEs have been seeing momentum. What, in your opinion, are the differentiating factors among these enterprises that attract investor attention?
It is difficult to comment on general investor attention in the SME space. From an Elevar standpoint, interest in enterprises lending to SMEs is driven by three key factors. First, enterprises adopting a ‘solution-oriented’ approach go beyond mere lending to encompass non-financial services supporting SME growth, thereby amplifying their economic potential. In addition, transactional data, increased digital visibility and phygital distribution have been critical in providing deep insights into the operations of SMEs. This enables SME-focused lenders to accurately assess risks and provide customised solutions to meet customer needs ensuring long-term customer satisfaction.
One segment that we observed gaining traction in 2023, was that of affordable housing finance. Do you foresee a pipeline of enterprises in this space?
Unlike most funds, we focus on all the high priority needs of the end customer segment and do not confine ourselves to a niche sectoral view. We recognize that the target segment, often undercapitalized vis a vis their growth aspirations, benefits from different kinds of lending products to infuse necessary capital to aid them in their growth journey. Affordable housing finance as a core need is one such product. Sometimes traction in a particular product varies, which is more a reflection of the market’s preference for secured loan portfolios over unsecured loans, based on the prevailing risk appetite. Nonetheless, these fluctuations are generally indicative of short-term trends rather than a fundamental change in customer needs. Instead of focusing on a specific product or sector, we believe enterprises that assess household economic health through transactions and view Entrepreneurial Households as a critical economic unit are the future.
As the microfinance model gains maturity in India, what are some of the emerging innovations you observe in the financial inclusion space that have potential for grassroot impact and commercial viability?
As the microfinance model matures in India, we have observed a remarkable evolution among low-income or bottom-of-the-pyramid customers. They have transformed into Entrepreneurial Households with significant growth ambitions for themselves and their children. With two decades of field insights and building ~50 companies, we have framed our thinking using a bottom-up customer view focused on transactions rather than the traditional discretionary income lens. We call this Core Transaction Value (CTV)™, a metric to dissect economic activities by mapping a household’s cash inflows (including curated borrowings) and outflows. To fully realise the potential of both impactful and commercially viable enterprises, innovations anchored on CTV across the value chain are waiting to be harnessed. Entrepreneurial Households demand high-quality core goods and services, especially in education, health, and financial services. As mentioned earlier, financial services, the ‘super sector’, is often the initial entry point for undercapitalized markets, and has the potential to amplify the impact significantly.
Given your past investments and learning in the financial inclusion space, what are the key risks for potential investors in this space – and how should one mitigate them?
In the financial inclusion sector, targeting undercapitalised customer segments presents a meaningful opportunity if lending businesses maintain rigour and discipline. First, success relies on customised value propositions, necessitating a deep understanding of borrowers’ needs, and the economic transactions driving their borrowing. In addition, assessing the founding team’s expertise in risk management, especially in credit underwriting and collections, and treasury management (debt and equity capital) is also vital. Finally, enterprises must implement cost-effective distribution strategies and efficient portfolio management models. Potential investors should be cautious of the challenges in achieving scale and pay particular attention to organisational design and leadership capabilities. A comprehensive view of entrepreneurial households’ economic activities, coupled with diligent risk management, can present impactful investment opportunities.
