Innovative Finance ISAs – the basics outlined for investors

There is much talk around Innovative Finance ISAs as an option for those looking for tax efficient investment wrappers. Here Elizabeth McCallum of Goji Investments outlines the basics of the product to date

 Innovative Finance ISAs – the basics outlined for investors

Elizabeth McCallum: the IFISA is a much needed tool to help investors generate real returns from their savings.

What is the Innovative Finance ISA?

Innovative Finance ISAs (IFISAs) were introduced in 2016 to encourage retail investors to invest in lending over peer to peer (P2P) lending and bond platforms. Investing in debt-based crowdfunding (investing via debt-based securities using platforms such as Goji) was then introduced from 1 November 2016.

Innovative Finance ISAs now sits alongside Cash, Stocks & Shares and Lifetime ISAs to give investors more diversity and choice over what to do with their ISA investments. Bearing in mind how low cash deposit rates are, and that inflation is starting to return, the IFISA is a much needed tool to help investors generate real returns from their savings.

The ISA rules of “only one of each type” still apply, so investors can invest in a single ISA of each type in any given tax year. The IFISA has the same annual investment limit as the existing ISAs. During the current (2018/19) and subsequent (2019/2020) tax year, individual investors can invest up to £20,000 across all of their ISAs put together.

How to open an Innovative Finance ISA?

Investors can only open an IFISA through HMRC authorised platforms, though not every investment platform that offers ‘debt’ investments (like P2P or Crowdbond platforms) will offer the ISA. For platforms to be authorised by HMRC they have to be authorised by the Financial Conduct Authority. Equally not all investors are eligible. Investors have to be over the age of 18 (IFISAs are not eligible for the Junior ISA) and UK resident (excluding the Channel Islands and the Isle of Man).

Once eligible investors have found an authorised platform, they will need to register and clear the platform’s Know-Your-Customer and Anti Money Laundering checks – both regulatory obligations. Once these checks are complete, investors will be able to open an IFISA directly on that platform. Until funds are invested within the ISA, the IFISA is only provisionally opened.

How does the IFISA compare to other ISAs?

Returns vary with the different assets that can be held in different ISAs. Returns are also likely to differ between different ISA providers. For example, the performance of a Stocks & Shares ISA will be highly contingent upon the performance of the stock market. Recently stock markets have been very volatile and this underscores the challenge of predicting how investments can perform. Nevertheless, must remember that past performance is not an indicator of future returns.

Most cash ISAs currently yield less than 1%, which is particularly challenging when inflation is greater than 2%, meaning investors are losing money in real terms.

With IFISAs, depending on the provider, it may yield between 3-12%. This is more lucrative than Cash ISAs, but more risky, although the Innovative Finance ISA may be considered less volatile than Stocks and Shares. The return should indicate risk, but this isn’t an exact science, and so investors should ensure that they understand the risks involved when investing, and not just invest in the highest yielding platforms.

It is important to realise that your capital is at risk when ‘investing’ in an ISA (rather than saving into an FSCS covered cash ISA) and that the value of your investments can go down as well as up. Investing in lending involves putting your capital at risk; borrowers may not repay all of their debts or they may repay the funds late or early (so not as much income is received as expected).

How has the Innovative Finance ISA been growing?

Following HMRC’s annual ISA statistics for the last tax year, the headline figures clearly show some impressive levels of growth:

  • £69bn was subscribed into ISAs in 17/18, an increase of £8.8bn on 16/17 and bringing total ISA funds to £608bn
  • £300m was subscribed to IFISAs by c.31,000 investors. This may seem small compared to the total amount of ISAs, but it is worth bearing in mind that this represents a growth in value of IFISAs of 805% from the 16/17 tax year
  • Compared to 2016/17, the number of stocks and shares ISAs rose by 246,000, Cash ISAs subscribed to fell by 697,000, IFISAs rose by 26,000.
  • Similarly, whilst the IFISA is still small compared to cash and stocks and shares ISAs, the 26,000 new accounts represent 620% growth from the previous year
  • Average subscriptions in all types of ISAs in 17/18 were £6,409, up 15% from the 16/17 tax year. The average value of an IFISA was £9,355 – nearly 50% larger than the average ISA.

Given that Direct Lending is one of the world’s fastest growing asset class, it is perhaps surprising that retail investors have lagged behind institutional investors who had invested $360bn into the sector by the end of 2017. The latest figures published by HMRC, however, show that retail investors, and financial advisers, are now embracing the sector and seeing it as a real alternative to cash and stocks and shares ISAs.

There are now over 36,000 IFISAs in total from the two years it has been in operation, and that number will be growing every year. Such rapid growth is surely a sign that the IFISA offers real customer benefit at a time when other more established methods of growing investors’ wealth are suffering their own challenges. The amount subscribed in cash ISAs has actually fallen for the third year running, likely due to the poor rates of return offered to savers, especially when compared to the rate of inflation.

Cash ISAs are still offering very low rates of return so investors are turning to the IFISA for low volatility income and additional diversification, as can be seen in the high percentage of transfers from cash ISAs. The market data suggests investors agree with what the industry has been saying for some time – that Direct Lending and the Innovative Finance ISA sits in between cash and equities when it comes to risk.

So what’s stopping investors?

Many people consider the IFISA to be risky because it’s new. But once upon a time, cash ISAs were new, as were VCTs and EIS investments – even investing into corporate bonds was considered risky in the 1980’s and now it is a multi-trillion market. There are risks involved, but these should be met head upon, understood and form the basis of an informed decision before investing (or not). For example, Goji helps manage these risks by diversifying investments across over 1,500 loans across different lending partners to offer a truly diversified solution. By investing across multiple sectors including SME, property, further education and renewable energy and deploying rigorous due diligence processes, we are constantly managing risk and seeking to offer peace of mind.

Elizabeth McCallum is marketing manager at Goji Investments

Further reading:

Lack of protection means Innovative Finance ISAs are not suitable for most private investors

ISAS – a basic guide to the different options

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