Comparing and Researching Innovative Finance ISAs
As the 2017-18 tax year end approaches, the complexion of the Innovative Finance ISA (IFISA) market is stark in comparison to this time last year and a far cry from end of 2016 calendar year – only two peer to peer lending platforms (P2P) offered an IFISA at the close of 2016.
The attractiveness for investors is three-fold: untaxed interest payments; risk-adjusted returns ranging 5% – 10%+ per annum; stable, uncorrelated credit to balance their portfolio. While the new ISA entrant – introduced April 2016 – suffered a modest start at best, the market has matured with almost all major P2P providers now offering their respective IFISAs onto the market. This includes Zopa, Funding Circle and RateSetter; the “Big Three” P2P providers.
Innovative Finance ISA Comparison
Despite the inevitable appeal of a few big brands (namely those mentioned above), there are actually over 70 firms which have the relevant permissions to offer the tax-wrapper – full FCA authorisation and HMRC ISA plan manager status are required. At Orca, we track the major players – both P2P and non-P2P – with IFISAs available.
Innovative Finance ISA Available – P2P Providers
Full FCA Authorisation – P2P Providers (IFISA not available yet)
Innovative Finance ISA Available – Bonds & Debenture Providers
Note: The above are a few examples, more can be found by visiting our ‘Innovative Finance ISA’ page.
Things to consider when conducting due diligence
Annual ISA allowance allocations
Your 2017-18 annual ISA allowance is £20,000. If you are a seasoned investor, you might allocate more to an IFISA if you have a greater risk appetite, or you may allocate less in order to take advantage of other tax-efficient investments which deliver higher returns.
For less seasoned investors, taking advantage of your Personal Savings Allowance may compel you to look at something that generates more than your cash ISA. Peer to peer lending does carry higher risk than traditional asset classes, however. Your capital is at risk from borrower default with no coverage from the Financial Services Compensation Scheme. This should imply lower allocations to P2P if you are a new, reasonably inexperienced investor.
Platform due diligence
Here are a few primary factors investors should evaluate when researching peer to peer lending platforms.
Default rates vs bad debt rates
If a platform has reasonably high default rates, it may reflect poor credit writing by the platform or stressed economic conditions affecting borrowers’ ability to repay debt. If the platform has a modest default rate and exemplary bad debt rate, this reflects the platform’s ability to recover debt; in cases, this may involve liquidating the borrower’s asset (usually property) which is securing the loan. It’s recommended that you view performance over time and also compare the platform’s estimated figure versus actual figure.
If you’re concerned by market concentration within your portfolio, P2P can provide balance by offering exposure to different markets, namely consumer, business and property. When conducting research, check which debt-market the platform focuses on, and whether it may contain a mix.
Are the loans secured or unsecured? If the former, what underwriting does the platform take; if property, what is the Value-to-Loan rate? If platform’s promote a ‘provision fund’ (contingency pot of money), check to see what level of the loan book the fund can pay out at. If the fund has enough to pay out at 3% of the loan book, but defaults have been rising to that level in recent years, it signals that the provision fund may not sustain and compensate a large number of losses in a serious downturn event.
Why investors are looking to the IFISA
What’s clear from the providers with IFISAs on the market is that experience and wealth play a large part in IFISA investing. Crowdstacker, one of the first providers to launch an IFISA, has recorded an average IFISA subscription of £11,000 – this compares to an average ISA subscription of £5,558, 2016-17 tax year. Zopa similarly viewed their main IFISA investors as those allocating £5,000 to £20,000, while millennials would dabble with hundreds of pounds.
Interesting to see a younger demographic engage with the asset class, but the early adopters of the Innovative Finance ISA are more experienced investors who are now transferring in old ISA money to an IFISA or redeeming existing P2P loans and reinvesting within the tax-wrapper. Aside from tax-free returns, here are a couple more benefits you can experience with P2P investing:
Balancing your overall portfolio with uncorrelated credit
With P2P lending, you can diversify into stable credit, yielding attractive risk-adjusted returns, which you would not typically be exposed to. P2P is accessible, quick and transparent, and now benefits from tax efficiency.
Your financial adviser would struggle to recommend P2P, given the asset class does not fall within a prescribed suitability testing format – it is hard to place on a traditional risk scale. But, for those capable of conducting due diligence and building a diversified P2P portfolio, returns have been consistent over recent years with very limited exposure to market fluctuations.
Complement your ISA portfolio
Many view the Innovative Finance ISA as sitting somewhere in between cash and stocks & shares ISAs. Cash returns are pitifully low, while stock markets suffer volatility; the Innovative Finance ISA holds stable investments, yielding attractive returns.
Typical cash ISAs are paying less than inflation. With P2P loans, the lower end of the return spectrum is around the 3% per annum mark.
Unsettled equity markets are causing uncertainty for stock market investors, so, again, the appeal of an uncorrelated asset class is very hard to ignore at a time when the recent market correction has caused anxiety amongst investors.
What is now becoming an assertive statement within the P2P industry, is that 2018 is the year when the Innovative Finance ISA will flourish. There’s not much time left to allocate your ISA allowance, so visit our Innovative Finance ISA page or get in touch with any questions.