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The Innovative Finance ISA (IFISA), a little oasis between a rock and a hard place?

 

By the last tax year more than 10.8 million people in the UK had done the ‘right thing’ and were subscribed to one form of ISA or another.

 

So, hurrah; twenty years after the launch of the tax-efficient wrapper a huge number of people have heeded DIY Investor’s clarion call for people to embrace financial self-reliance and Muckle’s determination to engage the next generation of savers and investors. Not so fast.

Recent research by the UK’s oldest peer-to-peer (P2P) consumer lender ZOPA – ‘The FeelGood Money Company’ –  found that 67% are concerned about fluctuations in the stock market, while 55% said they would be unlikely to consider a Stocks and Shares ISA in 2019

Neither are they fleeing to the traditional sanctuary of cash or bonds; less than one in three expect to save more this year than last year and after a decade of poor returns, Cash ISAs bombed last year, with 697,000 fewer accounts opened.

The current average return on an instant access Cash ISA product lags inflation at just 0.94%; Stocks and Shares ISAs also performed badly in 2018 with most delivering negative returns. IFISAs offer a higher risk-return profile than a Cash ISA and less volatility than a Stocks and Shares ISA.

Cash ISAs bombed last year, with 697,000 fewer accounts opened

Innovative Finance ISA (IFISA) provider Zopa concluded that its wrapper was ‘the perfect middle ground’ between poor returns and stock market volatility as consumers face a higher cost of living, Brexit uncertainty, higher inflation and low returns on their savings.

In announcing the results of its survey of 2000 people, Zopa’s Chief Product Officer, Andrew Lawson said: ‘2019 is going to be yet another challenging year for savers and investors, our research shows that people continue to be disappointed by traditional financial products like the Cash ISA or investing via the stock market.’

‘The IFISA stands as the perfect middle ground, offering a great alternative for people who want higher returns than Cash ISAs, but not the volatility of stocks and shares.’

‘P2P lending can be an incredibly effective way to diversify an investment portfolio. People looking to invest need to know what assets they are investing in and the related risks – personal loans in particular are reasonably stable and predictable.’

After a slow start, the IFISA is starting to gather momentum with subscriptions up 700% in the last year; however, potential investors may still be wary as all investments come with an element of risk.

Money put into P2P loans – with or without the IFISA wrapper – is not covered by the Financial Services Compensation Scheme (FSCS) which protects consumers’ savings in bank accounts up to £85,000 and certain investments up to £50,000.

The P2P industry is regulated by the Financial Conduct Authority (FCA) but your money is not covered by either element of the FSCS; this could concern investors at a time when several P2P platforms have said they are reviewing their return projections in the face of record consumer and business insolvencies.

Platforms such as Funding Circle have been stress-testing their proposition to reassure investors that they would be resilient in the event of a downturn or rising interest rates;  but what if they start granting riskier loans in order to meet growing demand from people wanting to lend through their platforms?

a great alternative for people who want higher returns than Cash ISAs, but not the volatility of stocks and shares

Neil Faulkner, of ratings agency 4thWay, believes that bad debts in P2P lending could be a symptom of the growth of the sector; in the early days there was so little money on offer that Zopa et al were able to be super-selective of its borrowers, approving just 0.5% of loan applications. However, Zopa now approves approximately 20%, meaning that it is not just approving the very safest loans, and the default rate has therefore risen.

Furthermore, having been through a period where default rates in P2P lending and the banks were unusually low, there is an inevitability that things would reverse, although Faulkner believes that current levels of defaults look ‘easily containable’.

The platforms generally operate schemes to protect their investors from bad loans, funded by investors’ fees.

All lenders via RateSetter pay into a provision fund which reimburses them if a borrower misses a payment; if the loan goes into default, the fund takes over the loan and repays outstanding capital to the investors.

According to RateSetter ‘no individual investor has ever lost a penny, although past performance is no guarantee of future success’.

Zopa, retired it’s ‘safeguard fund’ but says if it were to go out of business, it has plans to use loan servicing fees to cover the ongoing costs of managing its loanbook.

Growth Street has a ‘loan loss provision’ that has ensured that no investor has lost any of their initial investment or interest owed, despite 10 loans having defaulted; new kid on the block Loanpad continues to pay daily interest to investors if one of their loans defaults from its ‘interest cover fund’ until the loan has been recovered or a full capital loss occurs.

Faulkner says that P2P lending results are cyclical, but not to the extremes witnessed in the stock market; however he warns that lifeboat funds are not intended to completely protect lenders from a severe recession or property crash.

P2P lending results are cyclical, but not to the extremes witnessed in the stock market

If you currently have savings in an instant access Cash ISA, a ‘certainty’ is that in the current climate, the buying power of your money will be eroded, as none offer rates in excess of inflation.

With Brexit looming, or not, the stock market and its unknown unknowns, may not be for the faint hearted; those choosing to lend through P2P platforms should make sure they are spreading their money adequately across a large number of providers, and ideally hundreds or thousands of loans to contain the risks.

Aggregation is offered by recent entrants such as Goji Investments, Bond Mason and Orca Money, with each approaching it in a different way.

All aiming to deliver diversification to spread your risk, Goji creates monthly bonds comprised of direct loans, Bond Mason sells you tradable contracts to the right to receive interest on P2P loans, and Orca spreads your money across five other platforms.

The recently launched Orca ISA aims to open up the P2P market to retail investors and tackle previous barriers to investing across multiple platforms within one tax wrapper.

ISA rules only allow investors to subscribe new money into one IFISA per tax year; to build a diversified P2P investment portfolio in an ISA wrapper investors had to open separate accounts every year with different providers.

The Orca ISA gives them access to 5 leading P2P platforms at once, with investments starting from £100 and the objective of delivering stable, predictable, inflation-beating returns of up to 5.3%.

 

So, middling in terms of risk, but with the potential to deliver inflation busting returns that are uncorrelated to the stock market, 2019 could be the year that the IFISA takes off.

Platforms have generally proven adept at assessing borrowers and setting interest rates appropriate to their risk; however, low risk is not no risk and investors should do everything to ensure that they spread their money around and view reserve funds as a bonus rather than their main defence.

 

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