It has been a long wait for DIY investors but at last the Innovative Finance Isa (IFIsa) is taking root following its official launch in April 2016. This addition to the Isa family allows investors to generate tax-free returns from alternative finance products including peer-to-peer (P2P) loans and “crowd-bonds” sold on crowdfunding websites.
P2P loans and crowd bonds come in various flavours including personal and auto-finance loans, secured and unsecured lending to small businesses, property developers and housebuilders, and funding for renewable energy projects. (This might sound like the debt parcels of the credit crunch, but bear with me.)
The hold-up that hit IFIsas was that the leading P2P websites could not launch them until they had gained full regulatory authorisation from the Financial Conduct Authority, a longer process than some had hoped. Since May, however, two of the three largest P2P websites, Zopa and Funding Circle, have gained authorisation and in June Zopa launched its IFIsa, initially to existing customers. This starts to bring the IFIsa into the mainstream of DIY investing and there are now good reasons to take notice—not least because the annual Isa allowance jumped to £20,000 in April.
These loans and crowd bonds tend to offer net returns between about 4 per cent and well over 10 per cent depending on the risk profile of the borrowers—they’re riskier and less liquid than cash deposits, granted, but their historic performance is also considerably less volatile than shares or bonds. I place them between these two poles in risk terms.
The opportunity to invest via a tax-free account presents some interesting food for thought. The annual “Barclays Equity Gilt Study” reports that since 1899, UK shares have produced annual returns after inflation of about 5 per cent, while UK government bonds returned about 1.3 per cent, although over shorter periods these figures fluctuate wildly. In the 10 years to 2009, shares produced an annual real return of -1.2 per cent despite rising 25.9 per cent during 2009, while in the decade to 2015, the annual real return from shares (2.3 per cent) was trounced by gilts’ 3 per cent a year.
The historic data from new asset classes such as P2P loans is too short to draw firm conclusions, but I suspect that a diversified portfolio of P2P loans (spread across at least 100 borrowers) should provide long-term returns that are well above the rate of inflation. Given that the automated tools provided by P2P websites mean it is easy to reinvest capital and interest as it comes in, a portfolio like this should be able to grow at least 2 per cent a year in real terms and potentially rather more, depending on your risk appetite. A tax-free opportunity like that is worth looking at seriously.
This is especially true for those hit by progressive cuts over recent years in the lifetime allowance for pension contributions. Isas are already a useful second line of tax-advantaged saving for this group and the case for the IFIsa is particularly strong—if you have already built up a very large fund of pension savings that will inevitably be invested overwhelmingly in listed equities and bonds, the opportunity to diversify any further investments tax-free into different asset classes is especially valuable.
A broad basket of P2P loans held in an IFIsa and compounding at real rates of 2 per cent a year plus is not a bad place to begin.
