Risks

Investments in Triodos Microfinance Fund are subject to several risks, which are described in detail in the particulars relating to the sub-fund included in the prospectus of Triodos SICAV II. Some of the relevant risks are highlighted below.

Currency risk

Currency risk is the risk that changes in exchange rates may have a negative impact on the fund’s profits and assets. The reference currency for Triodos Microfinance Fund is the euro, whereas investments may be denominated in foreign currencies. Exposure to volatile exchange rates can affect the value of the investments and the fund’s assets. Triodos Microfinance Fund is therefore exposed to currency risk. The currency risk is mitigated by restrictions on the relevant exposures and, where feasible and economically viable, by the use of hedging instruments. The fund may invest up to 90% of its net assets in non-euro denominated assets. The fund’s investments denominated in unhedged local currencies are restricted to a maximum of 60% of the fund’s net assets. Furthermore, the unhedged exposure to any single local currency is limited to a maximum of 10% of its net assets. Currency exposures in the loan portfolio are mostly hedged, whereas currency exposures resulting from equity holdings are mainly unhedged. At year-end 2017, 81.5% of the net assets of the fund were invested in non-euro denominated assets (2016: 80.8%) and 23.5% of the net assets of the fund were invested in unhedged local currencies (2016: 23.6%). The largest single unhedged local-currency exposure as at December 31, 2017, was the Indian rupee (INR), at 3.4% of the fund’s net assets (2016: 4.0%).

During 2017, the fund suffered unrealised currency losses due to market fluctuations of EUR 37.1 million (2016: an unrealised gain of EUR 2.9 million). The result of the hedging contracts was positive and amounted to EUR 16.7 million, resulting in a net unrealised currency loss of EUR 20.4 million.

Hedged and unhedged positions (% of fund’s net assets), December 31, 2017

Allocation unhedged positions (% of unhedged positions), December 31, 2017

Exposure by currency (% of fund’s net assets), December 31, 2017

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USD

42.3%

 

Hedged

 

98.7%

Unhedged

 

1.3%

Local currency

39.3%

 

Hedged

 

40.3%

Unhedged

 

59.7%

EUR

3.7%

 

Other assets and liabilities

14.7%

 

 

 

 

 

 

 

Total

100.0%

 

 

 

 

Country risk

Country risk is the risk that political, fiscal or economic changes have a negative impact on the fund’s profits and assets. Triodos Microfinance Fund invests in countries that may be subject to substantial political risks, that may be suffering from an economic recession, perhaps entailing high and rapidly fluctuating inflation, that often have poorly developed legal systems and in countries where the standards for financial auditing and reporting may not always be in line with internationally accepted standards. The country risk is mitigated by applying an upper limit of 20% of the fund’s net assets for securities and financing instruments issued by or provided to entities that operate in a single country.

Representing 13.0% of the fund’s net assets (2016: 15.5%), Cambodia was the fund’s biggest country exposure as at December 31, 2017. The new regulation requiring MFIs and banks to cap their interest rates at 18% for all new loans disbursed from April 1, 2017 onwards, compelled the MFIs in the portfolio to downgrade their profitability projections. The fund did not make any provisions for loans outstanding to portfolio companies, but did reduce its exposure in Cambodia.

Access to hard currency, which had been a problem in Nigeria since the currency depreciation in 2016, improved in the course of 2017. In May 2017, the Central Bank of Nigeria introduced a new investor and exporter window, allowing for more liquidity in the hard currency market. This resulted in a significant reduction of the fund’s arrears position. As at December 31, 2017, the fund’s exposure in Nigeria was 0.11% of the net assets (2016: 0.68% of net assets).

The Indian government’s decision in November 2016 to demonetise the INR 500 and INR 1000 notes had an adverse effect on the portfolio quality of the microfinance industry. Portfolio companies with a large exposure to the microfinance sector, where repayment rates strongly depend on the availability of small bank notes, were hit hardest. The sector is increasingly returning towards normalcy and repayment rates for new loans are back to pre-demonetisation levels. SME lenders were less impacted by demonetisation, because they are less dependent on cash, although the segment also experienced a slow-down due to demonetisation as well as the implementation of the Goods and Services Tax (GST) in June 2017. As the effects of the policy are expected to gradually dissipate, the fund did not make provisions for outstanding loans. The stake in an MFI in North India was slightly reduced, however, due to its high exposure in the regions most hit by the cash shortages. As of December 2017, the Indian portfolio represents 12.6% of the net assets of the fund (2016: 12.5%).

Currency deregulation and liberalisation in September 2017 led to a 48% devaluation of the Uzbek som against the euro. While this fosters export competitiveness and attracts foreign investments, it also causes a deterioration of the short-term financial outlook for entities with foreign debt but local-currency income. The devaluation shrank the loan book of the two Uzbek banks in the fund’s portfolio in US dollar terms. As profits shrink for borrowers, an increase in non-performing loans is foreseen. Since US dollar-denominated loans represent only a small portion of the portfolios of the investee companies, the effect is expected to remain relatively small. As of December 2017, the Uzbek portfolio represents 1.5% of the net assets of the fund (2016: 2.0%).

Country risks are mitigated by diversifying the geographical exposure across a larger number of countries. In 2017, Triodos Microfinance Fund added three new countries to the portfolio: El Salvador, Honduras, and Lebanon.

Top ten country allocations (% of fund's net assets), December 31, 2017

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Country

Percentage

 

 

Cambodia

13.0%

India

12.6%

Ecuador

5.5%

Sri Lanka

4.0%

Kazakhstan

3.9%

Nicaragua

3.4%

Peru

3.3%

Bolivia

3.0%

Panama

2.9%

Paraguay

2.8%

 

 

 

 

Total

54.4%

 

 

Liquidity risk

Liquidity risk is the risk that the fund is unable to obtain the financial means necessary to meet its financial obligations at a certain point in time. Triodos Microfinance Fund aims to maintain sufficient liquid assets to meet its obligations under normal circumstances. As Triodos Microfinance Fund is a semi open-end fund, it may face large redemptions on each valuation day. This could potentially lead to a situation in which the fund needs to temporarily close for redemptions. The following measures can be taken to mitigate the liquidity risk:

The fund aims to maintain sufficient buffers in the form of cash or cash equivalents or to offer sufficient other guarantees. The cash buffers are determined every month based on historical inflow and outflow, projections of the inflow and the results of certain stress tests.

The investments in the fund are illiquid in nature, but can still be sold on a secondary market. Triodos Microfinance Fund has included transfer rights in its legal documentation.

The fund may decide to temporarily close for redemptions or subscriptions by suspending or restricting the purchase and issue of shares of the fund.

On December 31, 2017, the fund held 13.8% of its net assets in cash and cash equivalents (2016: 16.7%). In 2017, Triodos Microfinance Fund received repayments of maturing loans representing 11.1% of the fund’s net assets and received interest and dividend income on a quarterly basis. In 2017, liquidity was considered more than adequate for the fund to meet its payment obligations and facilitate the monthly subscriptions and redemptions of its shares.

Concentration risk

Triodos Microfinance Fund has a very specific, sector-based investment focus on microfinance and financial inclusion. The associated typical risks of microfinance will be spread to a limited extent only. The concentration risk is mitigated by applying an investment limit of up to 15% of the fund’s net assets for securities and financing instruments issued by or provided to the same investee. The largest single investee exposure as at December 31, 2017, was ACLEDA Bank in Cambodia, representing 10.0% of the fund’s net assets.

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