Most investors will be aware of cash ISAs and stocks and shares ISAs, but their lesser known relative – the Innovative Finance ISA – is worth exploring, particularly for those fortunate enough to be able to use their full ISA £20,000 allowance.
What is an Innovative Finance ISA?
Innovative Finance ISAs, or IFISAs as they’re usually known, became available to retail investors in 2016 to cover the growing market for Peer 2 Peer loans (P2P) and crowdfunding debentures. All investment platforms wishing to offer an Innovative Finance ISA have to be authorised by the Financial Conduct Authority. They effectively offer tax free wrappers for these alternative assets, offering investors more choice and the opportunity to diversify their portfolio and spread their ISA allowance across different asset classes.
It’s this opportunity to diversify the use of investors’ ISA allowance, plus decent returns and a few other characteristics that make them well worth considering, especially for those able to fully utilise their ISA allowance. Here’s our summary of 4 reasons why you should consider IFISAs:
#1 Innovative Finance ISAs are more risky but they can deliver higher returns
The P2P loans that qualify for the IFISA are deemed to be high risk by the Financial Conduct Authority (FCA). There are several good reasons for this. The counterparties (borrowers) are typically small firms in contrast to the large high street banks and building societies that provide Cash ISAs. The loans are not covered by the FSCS, which means that investors will not be compensated for losses if a platform or borrower folds. Investments in P2P loans are also difficult to sell and as a result investors may be unable to realise their investment for some time.
However, they generally offer higher returns than Cash ISAs. Moneyfacts.co.uk reports that Virgin Money’s 1 year Fixed rate of 4.25% is the most competitive Cash ISA rate on offer (8 Feb 2023). This compares with P2P platform Loan Pad’s IFISA of 3.8% Daily Access at the lower end and Crowd Property’s IFISA 8.5% at the higher end.
The research outfit 4th Way also claims that P2P platforms have performed well relative to the stock market. In an article in January 2023 they claimed that P2P platforms have consistently outperformed the stock market.
Samuel Mather-Holgate, an independent financial adviser for Mather and Murray Financial, neatly summed up the IFISA opportunities available currently in a recent article by P2P Finance News: “With all rate benchmarks increasing this year, P2P lending is now offering a very high yield in comparison to savings accounts,”
“Of course, the risk is correlated to the return but if you chose a good platform with a robust risk mitigation strategy you shouldn’t see delinquencies and default rates too much higher than they are now.”
#2 Innovative Finance ISAs have proven to be a good diversifier
Spreading funds across a broad range of assets is generally seen to be a good way for investors to reduce risk and IFISA investment products do not have exposure to stock market volatility and provide exposure to alternative assets such as property. As an example, P2P Finance News reported that default rates for the majority of peer-to-peer lending platforms fell dramatically throughout Covid. By contrast, the equivalent period was a volatile time for the stock market with the FTSE All Share falling from 4,235 on Jan 3 2020 to a low of 2837 in March 2020 and eventually recovering to 3,673 by the end of 2020. At the same time investors received meagre returns from Cash ISAs as the BoE reduced rates to stimulate economic growth. Therefore IFISAs proved their worth as a diversifier over that period.”
#3 Innovative Finance ISAs are good for providing passive income
Investors looking for long term, stable income, the types of investments found within an IFISA wrapper are seen as good options for delivering passive income. Payments are made monthly (and on one platform daily!), which compares favourably to dividends from stocks and shares. This fits better for investors relying on income to support a lifestyle, but it also allows savvy investors to reinvest and consequently accelerate compound interest.
#4 IFISAs can deliver social impact
Many crowdfunding models were set up to support parts of society that the broader finance market does not service well. For example, peer to peer lenders can provide bridging loans for those looking to buy a house or lend money to small house builders. Housemartin’s loans are used to provide much needed housing to people that need supported living such as those with learning disabilities or autism. Equally bond platforms offering IFISA’s, such as Triodos Bank’s, crowdfund money to put towards specific socially beneficial projects.
Whilst investment in stocks and shares can be tailored to provide an element of ESG impact, and banks offering cash ISAs may invest some of investors money in a similar way, there is less direct impact and you are effectively trusting them to put your money to good use, rather than picking specific causes yourself.
Know your ISA facts
The 2022-23 ISA allowance is £20,000. This is the total amount you can pay into ISAs during this tax year.
You can split your allowance between different types of ISA. For example, you could pay into a cash ISA and a Stocks and Shares ISA in the same tax year. But the total can’t exceed £20,000.
The current tax year ends on 5 April 2023.
Understand the risks
As IFISAs are categorised as high risk investments by the FCA, you also need to ensure that you understand the risks associated with the specific type of IFISA you are investing in. The FCA risk summary for Peer to Peer lending products, like Housemartin’s IFISA, can be viewed here.
You can also view reviews of P2P platforms on platforms such as 4th Way, Financial Thing and Obvious Investor.