IF Isas: a bold way to build your capital

IF Isas are the newest kids on the block, offering diverse ways to invest, but be aware that high rewards mean greater risk.

Innovative finance Isas (IF Isas) were introduced under George Osborne’s chancellorship, and went live in April 2016. There were a few teething problems, with both the tax office and the regulator (the Financial Conduct Authority) taking their time to approve providers.

This time last year, for example, none of the big three peer-to-peer (P2P) lending platforms – Zopa, RateSetter, and Funding Circle – had IF Isas available. But the situation has improved, and now more than 30 platforms offer them.

Yet despite their rapid proliferation, investors as a whole remain ignorant of their existence. More than 75% of those surveyed by specialist researcher AltFi Data shortly before Christmas said they weren’t aware of the products. But if you’re looking to diversify away from your stocks-and-shares Isa and want something a little more rewarding than the rock-bottom rates available on cash Isas, you might consider an IF Isa. Just be sure that you understand and are happy with the level of risk you’re taking – which is significant.

You won’t find any of the equity crowdfunding platforms such as Seedrs or Crowdcube offering IF Isas – equity investments are specifically excluded under the government’s rules. But you can invest in the usual P2P loans to individuals or businesses and lend money to fund commercial or buy-to-let properties, community energy projects, invoice financing (providing working capital to small businesses), or even independent film productions.

If you want to lend to consumers, you could try RateSetter, which offers up to 4.9% a year over five years. A far riskier option is FundingSecure. This platform offers 12% or more on sub-prime asset-backed lending – P2P pawnbroking, effectively.

On the lending to business side, Funding Circle offers 7.2%, but is currently only open to existing customers. Assetz Capital offers from 3.75% to 15% over various terms. Crowdstacker offers up to 7%. The UK Bond Network allows you to invest from £5,000 in individual corporate bonds from listed and unlisted businesses, returning an average of 11.1%. And if you prefer to invest in renewable-energy projects, Abundance Investments offers up to 15%.

Diversification may be tricky…

Your mouth may be watering at the sight of those rates, which is why it’s important to remember IF Isas carry the same risks as any other P2P investment. This isn’t a bank account – you can lose the money you invest, and it’s not covered by the Financial Services Compensation Scheme. In most cases your money is tied up for the long term, so if interest rates rise, you could lose out (if bank accounts start to offer better rates, today’s rates on risky loans will look a lot less appealing).

Secondary markets are not mature, and in many cases non-existent – so if you need access to your money urgently, you may not be able to get at it, and even if you can, some providers charge a fee for early redemptions. The rates indicated are not guaranteed, so what you actually receive may differ, especially if borrowers begin to default as the credit cycle turns.

One of the most frustrating aspects of the IF Isa regime is that it can be difficult to get real diversification. There are many flavours of crowdfunding, each offering vastly different products. But the rules state that you can only pay in (“subscribe”) to one IF Isa per year, with one provider. So if you wanted to combine property crowdfunding with invoice financing and renewable-energy projects, it can be difficult, as many IF Isa providers are very specialised.

Some P2P platforms – such as RateSetter and Zopa – do allow investors to “pool” their investments. The result is that your risk is spread over a wide cross-section of loans on the platform. However, you are still effectively putting your money into just one asset class – consumer loans, for example.

…and they have not been stress-tested

One platform, Goji Investments, offers “diversified lending bonds” to those who qualify as “professional, restricted, sophisticated or high-net-worth investors”. The bond, which offers a rate of between 5% and 6.5% on terms of between one to six years, invests in loans to UK businesses across a variety of direct lending platforms. It’s not cheap to employ a middleman like this though – the account has an annual management fee of 0.95%, and there is a minimum initial investment of £1,000.

The key thing to remember when dabbling in P2P is this: the higher the potential reward, the higher the risk. We haven’t seen how the sector will cope with an economic downturn yet – with the exception of Zopa, which was founded in 2005, none of the platforms have seen out a full business cycle. So far, times have been good to investors and the backdrop has been forgiving. But a downturn will come at some point, and when it does, the rate of defaults will rise dramatically.

Overall, if you’re concerned about the wider bond market (which we are), then tread very carefully and do your research if you’re considering putting your money into an IF Isa this year.