DIY Investor - The Do-It-Yourself Investing Blog

Cash ISAs fail to deliver anything more than paltry interest with Stocks and Shares ISAs performing at their worst since the 2008 financial crisis; Crowdstacker introduces the Innovative Finance ISA – what is it, and should you consider 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 £20,000 ISA allowance to invest in peer to peer (P2P) lending products, which may attract people looking for better returns than cash ISAs, or some stocks and shares ISAs, are currently offering.

P2P, or market place lenders directly match people willing to invest or lend with people or businesses wishing to borrow, at an agreed rate of interest; pretty much what the banks have traditionally done by lending out your savings.

However, rather than a bank lending the entire amount of money, a group (hundreds or even thousands) of individuals each directly lend a small part of it instead. 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.

P2P platforms can take several forms – some enable individuals to borrow money, others businesses; loans may be for a few months to a few years and as with most loans, as well as repaying the principle sum at the end of the loan term, the borrower also pays interest in the region of 3% to 12%, 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.

P2P platforms must have full FCA authorisation to offer the IFISA and currently few are able to do so; two that have been around since launch are Crowdstacker and Crowd2Fund.

Crowdstacker offers investors the chance to lend money to high quality British businesses that need money to expand, develop or diversify; borrowers are put through a rigorous screening process which includes not only basic credit checks but also reviews company accounts and creates bespoke loan terms to suit the business’ needs and protect investors.

All investments on its platform can be held in the IFISA offering returns of 5–7% according to the risk profile of the businesses.

A measure of its attraction is shown in Crowdstacker’s research which suggests that 90% of those investing in an IFISA have not invested with the platform before, with the average investment £7,700.

Other findings around its IFISA suggest that:

1 in 5 have invested their entire £20,000 ISA allowance
It appeals to all age ranges – 20s through to retirement
Monthly investment levels have remained steady since launch
7% have moved money from other types of ISA

So, although the IFISA is not yet available on all platforms, the potential for its popularity is clear.

The IFISA can create investment diversity

Because of the way the investments are structured, crowdfunding and P2P lending can open up new opportunities and diversify the exposure and risk profile of your portfolio.

Crowdstacker sees evidence of a strong urge from businesses in all types of sector and industry, to borrow away from traditional institutions, seeking access to ‘the crowd’ via its platform.

Therefore P2P may be compelling as a financing proposition for good quality businesses that are too small to issue bonds or float, and too big to rely purely on bank loans. These businesses could be sound propositions for everyday investors offering up exposure to different sectors away from the market-led pressures exerted on the stock market.

There may even be diversification within the loans themselves, with many individual borrowers offering multiple assets as security and with so many different loans, the risk to lenders can be lowered even further

What to look for in an IFISA

When you invest in the stock market, your money is not protected by the Financial Services Compensation Scheme and neither is it when you loan money via a P2P platform – often seen as a major drawback.

However, good quality platforms offer security features such as provision funds which cover some or all losses incurred in the event of borrower default; not a protection offered by stocks and shares investing.

Others structure loan agreements to include security features, for example a first charge over easily accessible assets valued at multiples of the actual loan amount.

Investors should consider security measures carefully before selecting an IFISA and be wary if any platform does not take care to ensure that you do not take on more risk than you can sustain.

When considering P2P lending, ask the same questions you would about a company when looking to make an informed decision about its shares or bonds:

Does the business have sound financial goals and structure?
Does its financial ratios seem promising? Short-term assets (cash, inventory and liquid assets) vs short-term debts; total debt vs total equity.
How does it compare with its competition?
How successful is the industry it operates in?
What is the loan’s date of maturity?

A business that provides convincing responses to all these questions could be a potential candidate to use P2P as a means to raise cash and because of a lack of funding supply are typically also willing to pay a higher reward to access funding in this way.

The hoped for end result is a win-win situation for those involved; businesses able to raise much needed cash more easily and with favourable terms, and access to good quality investment opportunities and higher level returns for investors.

With the added bonus of tax exemption, investors may consider P2P lending within an Innovative Finance ISA wrapper as part of their investment portfolio.

_{Risk warning}

_{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.}