Getting More out of Your ISAs
Cash ISAs are still failing to deliver anything more than paltry interest rates¹, whilst research suggests 2015/16 Stocks and Shares ISAs performed their worst since the 2008 financial crisis². But what about the new alternative, the Innovative Finance ISA? What is it, and should you be considering adding it to your portfolio?
The Innovative Finance ISA (IFISA) was introduced by the Government at the start of the 2016/17 tax year to enable investors to hold peer to peer loans in an ISA wrapper. As with other types of ISA, investors can use all, or some, of their annual £15,240 ISA allowance to invest in peer to peer (P2P) lending products. Since their introduction they appear to be extremely popular with people looking for better returns than cash ISAs, or some stocks and shares ISAs, are currently offering.
For those not familiar with P2P lending, the easiest way to think of it is as directly matching people willing to invest or lend with people or businesses willing to borrow, at an agreed rate of interest.
It’s pretty much what the banks have traditionally done; they use your savings to lend out to people or businesses. The difference is that rather than a bank lending the entire amount of money, a group (often several hundreds or even thousands) of individuals each directly lend a small part of it instead.
‘directly matching people willing to invest or lend with people or businesses willing to borrow’
Unlike some savings products, P2P returns are not guaranteed, but forms of security, such as first charge over the borrowing business’s assets, are often offered.
Lending money through peer to peer platforms can take several forms, with some enabling individuals, and others enabling businesses, to borrow money. Money is typically lent for anything between a few months to a few years.
And, just as with loans that we are all familiar with, as well as repaying the principle amount at the end of the loan term, interest is also paid by the borrower of anywhere in the region of 3% to 12%. These vary depending on risk levels and loan terms.
With interest rates like this on offer within a tax-free ISA wrapper, it is easy to see the appeal to investors looking for higher regular returns.
Where can you get an IFISA?
To get a licence from HMRC to offer the IFISA, P2P platforms must have full FCA authorisation, and currently there are only a handful of platforms that have this. Consequently, there are only a few IFISAs currently available, but two that have been around since the start of the current tax year are those offered by Crowdstacker and Crowd2Fund.
Taking Crowdstacker as an example, this platform offers investors the chance to lend money to high quality, established British businesses which need money to expand, develop or diversify.
To be allowed to raise money on the platform all qualifying businesses must complete a rigorous screening process which includes not only basic credit checks but also reviews of company accounts and the development of bespoke loan terms which suit the business needs and build in appropriate protections for investors.
‘offers investors the chance to lend money to high quality, established British businesses’
All investments Crowdstacker offers on its platform can be held in the IFISA. And, in line with the risk profile of the businesses it raises money for, returns could potentially be in the region of 5-7%. Crowdstacker recently released some interesting data about how its IFISA was doing which clearly shows it is attracting a lot of interest from investors.
For every ten Crowdstacker IFISA investments, internal statistics show that around nine come from people who have not invested with the platform before, with the average amount invested in the region of £7,700. Internal statistics also show that just under one in five (18%) have chosen to realise the full tax benefits for their P2P investments by using their full annual allowance of £15,240 in the IFISA.
Crowdstacker’s data also reveals some other interesting patterns:
- The IFISA appeals to all age groups ranging from investors in their 20s through to those in retirement
- Investment levels using the IFISA have remained steady in each month since launch
- Interestingly, nearly one in ten (7%) people have taken the opportunity to move money from other types of ISA investment
So, although the IFISA is not yet available on all platforms, the potential for its popularity is clear.
An Example of IFISA Money in Action
IFISA money was, for example, a big contributor to one of Crowdstacker’s current raises, for BurningNight; an exciting, innovative and already very successful business which operates bars in City centres in the North and West of Britain.
BurningNight is seeking to raise a total of £3.5 million through Crowdstacker, money it plans to use to open new sites in Nottingham and Birmingham as well as refurbish and extend the original bar in Leeds.
The raise attracted over £1 million within just a few weeks of opening, and over half this money was invested via the IFISA. The terms of the loan are that BurningNight will repay the loan at the end of three years, and pay 7% pa interest paid quarterly.
This means investors putting in their full £15,240 ISA allowance could make over £1,066 per year interest. Not a bad proposition when you consider you pay no income tax on this.
The IFISA can Create Investment Diversity
Although it might not be immediately obvious, it is worth exploring just how innovation such as crowdfunding and P2P lending opens up new opportunities which can diversify your exposure and risk. P2P can potentially create subtle differences in how investments are structured leading to broader exposure and potentially reduced risk within the range of ISAs you hold, as well as your overall investment portfolio.
‘a strong urge from businesses in all types of sector and industry, to borrow away from traditional institutions’
Let’s take what we do at Crowdstacker as a good example of this. Everyday a number of various types of businesses contact us to look at how they can use ‘the crowd’ as a way to raise finance on our P2P platform. We see evidence of a strong urge from businesses in all types of sector and industry, to borrow away from traditional institutions.
This means, as a financing proposition, P2P may be very compelling for good quality businesses that are too small to issue bonds or float, and too big to rely purely on bank loans. These types of businesses, operating in a variety of sectors, could be sound investment propositions offering up exposure to different sectors, and away from the market-led pressures exerted on the stock market, creating potential for everyday investors.
And even within the loans themselves there can be diversification, with many individual borrowers offering multiple assets. For example, a loan opportunity Crowdstacker is featuring throughout 2016 seeks to raise £10 million for Amicus.
Amicus is itself a lending business, with much of its work coming from short term property lending. It has lent somewhere in the region of £500m³ to more than a thousand borrowers.
Amicus has a very low default rate of less than 0.15%, and in the process of creating a bespoke loan product for the business, it was willing to provide more than adequate security – over £45m assets secured against the £10m loan.
In this way money raised on the Crowdstacker platform and then used by Amicus is diversified across so many different loans, the risk to lenders can be lowered even further.
What to Look for in an IFISA
Detractors from the growing P2P lending industry often cite concerns about the security of investors’ money. Just as when you invest in the stock market, money is not protected by the Financial Services Compensation Scheme.
‘find out what you need to know to make an informed choice’
However, other security features, which are not offered by stocks and shares investing, are generally offered by good quality platforms. These may include provision funds which are in place to cover some or all losses sustained in the event of borrower default. Others structure loan agreements to include security features, for example a first charge over easily accessible assets valued at multiple times more than the actual loan.
Investors looking into P2P and/or opening an IFISA should look at and consider security measures carefully before investing. And take note that no good quality platform would advocate investors to take on more risk that they can sustain.
Stick to the sorts of questions you will be used to asking yourself about the stock market or bond investing, and you should find out what you need to know to make an informed choice. Questions such as:
- Does the business I am thinking of lending to have sound financial goals and structure?
- Do the financial ratios seem promising? This includes comparing its short-term assets (such as cash, inventory and liquid assets) to its short-term debts and comparing its total debt to its total equity.
- How does it compare with the competition in the industry?
- How successful is the industry as a whole?
- What is the loan’s date of maturity?
Lending to businesses can be rewarding, but it involves a number of risks. If you lend through Crowdstacker, please be aware that you may lose all of what you lend. There is currently no active secondary market for the underlying loan to be transferred if you need access to the capital. You should not lend more than you are prepared to lose. For more information consult our full risk warning https://crowdstacker.com/risk-warning. Money lent is not insured or covered by the Financial Services Compensation Scheme. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
Crowdstacker Ltd. is authorised and regulated by the Financial Conduct Authority (frn. 648742).
Please note all data referencing the progress of the IFISA used in this article has been sourced from Crowdstacker’s analysis of investment in its own IFISA.