The Innovative Finance Isa is a curious beast.
Designed to bring Isa investing to the brave new world of peer-to-peer lending, it carried great expectations but arrived as a damp squib.
At launch two years ago, there were no major providers with Innovative Finance Isas ready to go.
That slow start is a distant memory now and this year has seen plenty of firms pushing investors to try something new with their Isa.
But should they?
The Innovative Finance Isa carries an official tag but no FSCS protection and some unusual investment opportunities meaning there is a touch of the Wild West about it
Perhaps, but only with a bit of their Isa money, only if they properly understand the risks and only if they are willing to dig into what lies behind tantalising high interest rate returns.
The Innovative Finance Isa is designed for peer to peer lending, which involves an investor using a platform to make loans to consumers or businesses in return for an interest rate return – typically two to three times that on cash.
It’s often described as like banking that cuts out the middleman, but this is not strictly true as banks don’t work this simply and there is still a middleman – the peer to peer platform that you use.
But it does remove a lot of the costs that the bank as middleman incurs, which theoretically means better returns for investors without bumping up rates for borrowers too much.
This often gets bracketed under the banner of crowdfunding, however, there are two types of crowdfunding and only the peer to peer lending element can be included in an innovative Isa, not the equity version where investors take a stake in a company.
It’s also important to note that while only FCA-regulated platforms can offer an Innovative Finance Isa, they come with no protection.
Obviously, innovative Isas don’t qualify for the savings element of the Financial Services Compensation Scheme that protects up to £85,000 per licensed bank.
Crucially, however, neither do they get the FSCS investing element that covers up to £50,000 in case your investing platform goes bust and hasn’t done what it is meant to with your money.
Just because it’s got an Isa tag, doesn’t make it safe.
The UK’s peer to peer lending movement sprung out of three main firms, Zopa, Ratesetter and Funding Circle, which built their businesses mainly on unsecured lending to consumers and small business.
The problem with unsecured lending is that if the borrower fails to pay back their loan you will struggle to get your money back, as you cannot take any of their assets in its place.
All three have enviable records on defaults, with little damage from bad debts and their own methods of protecting investors. It’s worth remembering that these haven’t been properly tested in an economic crash or rapidly rising interest rate scenario, however.
Beyond those big trusted names, there are lots of players out there and it can be difficult to work out what you are invested in and how solid their claims are – even if your loans are secured.
Ideally, you want your loan investments to be secured on an asset, which can be taken and sold to pay you back if the borrower defaults.
The advantage here is that while you may end up with a liquidity issue, as you have to wait to get your money back, your capital should be safer, ie the money you invested is secured against a property.
For example, there are a slew of innovative Isa platforms offering high rates of 7 per cent plus that allow investors to make secured loans to property developers. Many say they lend at low loan-to-values, with the proper scrutiny of due diligence carried out, and argue that investors should get their money back if a borrower fails to pay up, as properties can repossessed.
That’s all well and good, but without any FSCS investing protection you also need to evaluate the platform itself, its claims on how well it has assessed borrowers, the rates it lends at (are these bridging loans at 20 or 30 per cent interest) and how watertight its contracts are.
That’s pretty tough for the average investor. So, it seems to me that it is very important here to look for reputation, robust backing and as much evidence as possible that things are being done as they are meant to.
Many of these firms are reputable and some are well-known to This is Money, but we’ve looked at others and asked ourselves ‘who are they?’
There’s a touch of the Wild West to the Innovative Finance Isa, so tread carefully.
How I would approach Innovative Finance Isa investing
Don’t mistake my caution above for a belief that peer to peer lending isn’t worth doing, or that the Innovative Finance Isa is not a good addition to our investing options.
I do think that there is a potential place for this in investment portfolios but that it pays to err very heavily on the side of caution as this industry is yet to be really tested – and there is no protection if things haven’t been done right.
To that end I would look to invest a small part of my portfolio and consider this to be at the riskier end of my investments – not a replacement for the safety of high quality bonds and certainly not for cash.
I would also aim to invest with those who have a track record, experience, longevity and professional experience.
This is by no means an exhaustive list, but here are a few examples of places I would consider looking and why.
The big three: Zopa, Ratesetter and Funding Circle
As mentioned above, the trio of Zopa, Ratesetter and Funding Circle were the trailblazers for peer to peer lending in the UK.
They have won a string of awards and come with solid reputations.
Zopa has a waiting list for people to invest and currently offers two main products, Zopa Core at 4 per cent and a higher risk Zopa Plus at 4.6 per cent, with loans spread over different borrowers.
There is no fixed term but if you invest for short periods you are likely to get less than this and there is a 1 per cent fee for selling loans to other investors on its marketplace. Its expected default rate is 4 per cent but actual defaults have proved much lower over time. Zopa has retired its Safeguard Trust, which protected lenders against bad debts but you can now offset these against income from other loans.
Ratesetter lets you invest in a portfolio of loans to individuals, businesses and property developers. It has a Provision Fund protection and that means that so far no investor has lost money to defaults. The rolling easy access rate is 2.7 per cent, one year rate is 2.9 per cent and five year rate is 4.6 per cent.
Funding Circle involves lending to British small businesses. Its automatic lending tool lets you lend money to hundreds of firms easily, who borrow over six months to five years. Projected returns on the conservative account are 4.8 per cent and 7.2 per cent on the higher risk balanced account. Those projected returns take account of forecast bad debts but higher defaults will eat into these rates.
Away from these three, there are a variety of other platforms that have been around for some time, Thincats lends to businesses, LendInvest, LandBay and Assetz lend on property, as does Octopus Choice, which is newer but an arm of the major Octopus finance group.
Evaluating propositions can be tricky, but as an example of investing on reputation, track record and professional experience, there are two firms who have come into visit me recently that provide an opportunity for a closer look: Triodos Bank and Amberside ALP.
Triodos is Britain’s leading sustainable bank and has launched a crowdfunding platform that includes peer to peer lending in an innovative Isa
Triodos is Britain’s leading sustainable bank and has a solid reputation. Its platform www.triodoscrowdfunding.co.uk offers people the chance to invest via an Innovative Finance Isa into bonds issued by organisations that it says are ‘delivering positive social and environmental impacts’.
Outside of an Isa there are also opportunities to invest by taking a stake in an organisation’s equity
Investors receive an interest rate return back on their bonds over a set period of time.
It is possible to invest from £500, although Triodos says some investments will have lower minimums. The organisations will often be raising money for a specific project or endeavour and they will have been ‘extensively screened’ by Triodos for ‘social and environmental impact, the viability of their business model and the credibility of the management team.’
One example is Thera Trust, which provides care and housing for people with complex learning disabilities, aiming to raise £5 million to provide 14 new homes. Investors will earn 5.5 per cent interest per year over a 6-year term.
Amberside is backed by a team with a long track record in the investment industry and offers investments in projects such as a large hydroponic greenhouse tomato farm
Amberside ALP is a new name but has been launched by the team that previously owned and ran the Club Finance business, which specialised in VCTs, EIS and also owned the Frequent Trader platform. This was recently sold to Wealth Club.
Its platform is designed for direct investors but investment is also available through financial advisors and soon through DIY services, such as Wealth Club.
The idea behind it is to allow investors access to the kind of deals usually only offered to private banks and high net worth investors, with carefully assessed lending on asset-backed infrastructure schemes.
Amberside says it has a pipeline of loans currently being evaluated on UK projects, including solar farms, effluent treatment facilities, hydroponics project and grid support infrastructure.
The idea is to spread investors’ money across a portfolio of projects but at launch just one is live, a £17.5million loan to a Suffolk hydroponics operation to build a large greenhouse that will grow premium tomatoes for a major supermarket.
Amberside says the lender has first charge over all the borrower’s assets, including a 25-year lease on the land and projections show the borrower should generate 50 per cent more cash than that needed to service the loan. A £5million cushion of equity is also being raised by the project.
There are one-month access, two-year bond and four-year bond options expected to pay 3 per cent, 3.5 per cent and 5 per cent, respectively. Early bird investors get a higher rate to reflect the greater risk of investing in a smaller number of projects, with 4.25 per cent over two years and 6.75 per cent over four.
Amberside is an example of an investment where you would be trusting in the reputation, experience and professional due diligence of the people running the platform, in order to offset the risk. You will need to do your own careful research into this.