[Editor's Note: This is the second in a three-part series on the growing field of impact investing, in which investments are designed to generate both financial return and positive social and environmental impact.   

The series explores the progress, challenges and practical applications of impact investing in the context of institutional portfolio management and looks at emerging investment strategies in forest carbon, microfinance and energy efficiency. The first segment is available at GreenBiz.com.

The posts are written by industry practitioners and drawn from content created for a new course at the University of Michigan's Erb Institute for Global Sustainable Enterprise.]

With global markets still recovering from the 2008 financial crisis and the reputation of many traditional financial instruments tarnished, investments in microfinance institutions (MFIs) have emerged as a promising option.  

The basic business model of microfinance focuses on creating sustainable long-term economic value for all stakeholders. Leading MFIs are characterized by high portfolio quality and strong profitability and operate in a market with many still-to-be-realized opportunities.

Microfinance commonly falls under the broad green business category because it is often associated with its positive social impacts -- its products and services realize the social and capital aims of its clients, including an increase in income, assets and fulfillment of basic needs. 

To scale its social mission, microfinance embraced a sustainable business model which allowed MFIs to expand beyond donor capital. Today the microfinance industry includes billions of investment dollars from commercial institutions.  What qualities have made MFIs a compelling financial proposition?

The numbers of the microfinance industry may surprise you: MFIs manage in excess of $40 billion in assets with a client base that exceeds 100 million borrowers. In fact, a recent publication from the Financial Access Initiative reported that there are 800 million low-income adults using formal and semi-formal financial services offered by a variety of channels including microfinance.

However, the report also concludes that there are 2.5 billion adults who remain outside of the formal financial system, quantifying the outstanding opportunity for microfinance. As MFIs pursue this opportunity, they'll need additional investment from the capital markets. Thus a better understanding of the unique financial attributes that define these institutions is necessary. This article summarizes what we believe are some of the most compelling attributes.

A View of the Microfinance Market

Emerging markets are enjoying an astonishing -- if complex -- ascension. These regions' share of global GDP (adjusted for purchasing power parity) rose to 45 percent in 2008 from 36 percent in 1980; multinational corporations predict that 70 percent of global growth in the next several years will come from emerging markets. 

With this growth comes the expansion of purchasing power and the creation of new markets for goods and services across the socio-economic spectrum. Even the massive low-income demographics known as the Base of the Pyramid (BoP), the 4 billion-person market whose households earn less than $3,000 a year, are being engaged in a meaningful manner. In aggregate, their economic strength is impressive. Renowned strategist C.K. Prahalad estimated the GDP of the BoP to be $13 trillion and the World Resources Institute measured their annual expenditure on goods and services at $5 trillion.

Over the last decade, the business community has come to appreciate that this low-income demographic possesses enormous economic power. Financial services is no exception. Microfinance, the provision of formal financial services to low-income communities, has exemplified the essence of BoP business models: deliver a relevant affordable product at scale. Since the 1970s, a wide array of development and commercial agents cultivated microfinance into an industry with meaningful products and services targeting the economically active poor.

Matching MFIs with Market Demand

In the realization of scale, MFIs have developed compelling and distinct attributes compared to other emerging market financial sectors. Based on an analysis of the financial characteristics of MFIs, there are fundamental differences between microfinance and emerging market commercial banks, which make microfinance as an investment worthy of consideration. These distinctions relate to the intrinsic credit quality of MFIs and their established financial metrics as well as the environment of support that is specific to the microfinance industry.

Next Page: How MFI's stand out from the traditional finance crowd.