What experienced investors need to consider when choosing an IFISA

By Jo Bentham3rd February 2020

An Innovative Finance ISA (IFISA) allows investors to use their annual ISA allowance - which is £20,000 for the 2019/20 tax year - to lend funds through the peer-to-peer (P2P) lending and debt-based securities market while receiving tax free returns and capital gains.

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IFISAs were introduced by the UK government in 2016 in order to allow investors to take advantage of the P2P lending and debt-based securities market with the added benefit of ISA tax relief. 

 

Tax benefits of IFISAs

Tax is an important investment consideration. It can take a big chunk out of any returns, but investing in a tax-efficient way can turbo charge your investments.

This is the big advantage of ISAs. Through an ISA, you can invest up to £20,000 in the 2019/20 tax year without paying tax on any returns. 

There are now seven types of ISA, the main three being Cash ISAs (instant-access and fixed-rate), Stocks and Shares ISAs and IFISAs.  

As the name implies, with a Cash ISA your investment is in the form of cash, on which you receive tax free interest. With a fixed-rate Cash ISA, you agree to locking your money away for an agreed period of time, and in return for this commitment, you receive a fixed-rate of interest, which is usually higher than what is received with an instant-access Cash ISA.

With a Stocks and Shares ISA, your money is invested in company shares and in government and corporate bonds. Your investment can earn a return from dividend and interest payments, as well as any capital gains resulting from a rise in the value of the investments. The rates of return will typically be higher than those available in either of the two types of Cash ISA.

IFISAs allow experienced investors to invest in the P2P lending market and debt-based securities, while offering the same tax benefits as above - any interest earned and capital gains are tax free. Below, we talk through the four main IFISA types - property, green energy, SME lending and consumer lending. 

 

Types of IFISA

The main funded IFISAs include;

  • Property
  • Green energy
  • SME lending
  • Consumer lending

Property 

A property IFISA allows investors to lend money to borrowers to fund property projects - including residential development and commercial development - while receiving tax free returns. With property loans, investors will receive interest payments at regular intervals - as well as being paid back the amount loaned at the end of an agreed fixed term - giving them a relatively certain stream of income.

Returns on P2P property loans average between 3% and 12%, and they vary in terms of risk. Though property IFISAs are not protected by the Financial Services Compensation Scheme (FSCS) and your capital is at risk, they are often asset-backed. This means that your investment is secured on the assets, such as the land the properties will be built on, so in the event of the development company going bust, in some cases your capital can be repaid via sale of these assets. 

It’s estimated that 340,000 new homes need to be built in the UK each year until 2031 to meet demand, but only 241,130 were completed in 2018/19. This rising demand, and limited supply, means that house prices are likely to continue to rise - the average house price in the UK was £4,640 in 1969, and had risen to £223,405 in 2007 - and property has performed particularly well in the UK in recent decades, making it an important addition to any well-diversified portfolio.

Green energy

Green energy IFISAs give investors the chance to earn returns, while doing their bit to help the planet by supporting renewable energy projects such as hydropower stations and wind farms. 

Average returns of 3% to 15% are available from green energy IFISAs, however, since the government scaled back green energy subsidies, these IFISAs have become a little more risky.

SME lending

SME loans are one of the most popular products offered by IFISA providers. Investors are able to lend money to small and medium sized businesses, who have found it increasingly difficult to secure loans from banks after the financial crisis. 

SME loans can be secured or unsecured, with the general rule that unsecured loans are riskier - as in the case of a default it may be harder to get your money back - but offer higher returns. Returns on SME IFISAs average between 4% and 15%.

Consumer lending

Consumer loans make up a large part of the P2P market, after P2P platforms began offering them to consumers who could not secure reasonably-priced loans elsewhere. 

P2P lenders offer consumers loans at competitive rates, meaning returns for investors are generally low - averaging between 3% to 6%.

 

Diversifying with IFISAs

Diversification is an important investment principle. Traditionally, the diversified investment fund approach has been to go for a combination of asset classes to maximise the potential for a smooth return over the medium to long-term. 

If you were to put all your money into one industry, sector or geographical region, and they do badly for any reason, so will the value of your whole portfolio. But, in a carefully chosen and balanced range of investments, not only will your exposure to one type of asset be limited, but often falls in the value of one will be compensated by rises in another.

IFISAs can provide experienced investors with a great opportunity to curate a well-balanced investment portfolio, offering a range of investment types and providers.

 

Risk vs returns

In terms of risk versus reward, IFISAs sit between Cash ISAs and Stocks and Shares ISAs. They will typically pay a better rate of return than a Cash ISA, but with a greater element of risk. However, they can be less volatile than a Stocks & Shares ISA, even if they tend to pay a lower rate of return. 

New rules introduced by the FCA on January 1st 2020 regarding the promotion of speculative mini-bonds mean that only experienced investors classified as either sophisticated or high-net-worth are eligible to invest into mini-bonds.

Though investing into mini-bonds through an IFISA is now restricted, everyday (restricted) investors may still be eligible to invest into other types of IFISA - such as SME lending, consumer lending and green energy - though the FCA states that everyday investors new to the P2P sector must not invest more than 10% of their investable assets. If you’re unsure about your investor classification and whether you’re eligible to invest, you should speak to an independent financial advisor and check with individual platforms about their eligibility criteria. If you need a quick reminder about what each of the investor classifications mean, click here

In regards to the highest and lowest risk IFISAs, this varies depending on a number of factors. For example, asset-backed property IFISAs are considered one of the safest, but there is still the risk of an economic downturn affecting returns, meaning you may not get back the amount invested. Also, in the event of default, the security held doesn’t guarantee the return of your capital. One of the least safe could be SME lending IFISAs - as investing into small and medium sized businesses or start-ups comes with a high risk of failure, especially when compared to larger, more established businesses - but again, this varies depending on whether the SME loan is secured or unsecured.

It’s important that you aim to achieve an element of diversification with your IFISA portfolio, ensuring you have a spread of investments across different sectors, industries and geographical locations.

Read more: IFISA: understanding the risks vs the returns

 

Conclusion

There are a variety of IFISA types - from property to green energy - and a variety of providers, offering a range of target returns. It’s important that you consider your risk profile when choosing which type of IFISA to invest in - as different IFISA types carry different risks, depending on what your capital is being invested into - as well as aiming to build a diversified investment portfolio in order to mitigate risk.

You should avoid putting too much money into one industry, sector or geographical region, because if they perform poorly, so will the value of your whole portfolio. Before making a decision on which IFISA you are going to invest into, you must do thorough research - considering things such as, is the IFISA asset-backed? Do you have a good understanding of the market and sector you’re investing into? - and advice from an independent financial advisor is recommended.

 

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The MAVEN Bonds product is aimed at experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).