How to Master ISA Diversification with IFISAs
When the Innovative Finance ISA was introduced in April 2016, it was billed as a simple way to invest in peer-to-peer lending tax free.
But as P2P sector has evolved, it has become clear that there is no ‘one size fits all’ model of P2P lending.
Today’s IFISA providers define themselves in a range of different ways, from property-backed platforms, to marketplace lenders, SME finance platforms, mini bonds, and alternative lenders.
While current rules dictate that you can only open one new IFISA account per year, long-term investors have the opportunity to build up a surprisingly diverse portfolio of IFISAs over time.
This is especially true if you also hold others types of ISA too – thus diversifying your investing strategy further.
With this in mind, we thought it would be useful to put together a short guide to IFISA diversification…
There are two ways to diversify your IFISA investments.
Firstly, you could simply invest via a platform which offers pooled loans. This means that any deposits are automatically spread across a variety of different loans, reducing your exposure to potentially ‘bad’ loans, and ensuring that you are invested in several smaller deals as opposed to one big project.
The other way to diversify your IFISA investments is to open a new IFISA account every year which focuses on a different element of the sector. Here are just a few of the myriad options available within the tax-free wrapper…
Property-backed IFISAs allow investors to fund building projects, property developments, buy-to-let properties, commercial real estate or residential homes.
Many IFISA holders like the idea of funding bricks-and-mortar properties, as the building itself can act as a form of collateral against the loan.
Most property-backed P2P platforms will only lend up to 70 per cent of the loan-to-value (LTV) on any given property, which means that the building needs to drop in value by at least 30 per cent before the lenders’ investment is at risk.
To put this in perspective, during the property crash of 2008, the average property dropped in value by 18 per cent.
The other benefit of property-backed IFISAs is that they tend to offer high returns – often in the double digits.
However, the most generous investments do come with higher risk. For instance, property developments are considered to be among the riskiest projects in the P2P sphere, as there is a risk that construction could stall, leaving the property in debt.
For this reason, it may be prudent to invest via a platform which invests alongside its lenders, or through a platform where any money invested is spread across a series of different real estate projects with varying degrees of risk.
Small and medium-sized businesses have been flocking to the P2P sector in recent years as they find it increasingly hard to get funding from traditional banks.
As a result, there are some great opportunities for P2P lenders who want to support UK businesses while making inflation-beating returns.
Most SME lending platforms will showcase each and every business that they lend to, allowing potential investors to do their own due diligence.
So-called ‘ethical’ IFISAs will only invest in projects that promote green initiatives or socially-responsible projects. These might include social housing developments, geo-thermal plant construction, wind farms or solar energy manufacturing.
These loans are popular as they offer hefty returns to investors, and the peace of mind that comes with making ‘ethical’ investment decisions.
However, the ethical ISA space has been rocked in recent years with the end of government subsidies. This has left some clean energy projects in limbo, placing investor capital at risk.
If you are investing in clean energy IFISAs, it is always worth checking the small print to make sure that the project isn’t reliant on government help or other external factors.
Mini bond IFISAs
Mini bonds have been used by corporations for years as a way of raising money quickly for short-term use. But over the past few years they have been co-opted by the P2P sector and rebranded as direct lending opportunities.
Investors pledge a certain amount of money across a set period of time, then the bond holder (usually an SME) will pay a fixed rate of interest on a monthly or quarterly basis.
At the end of the term time, the capital is paid back, unless of course the bond holder defaults.
By investing in a mini-bond, IFISA holders can access higher returns than they would find with traditional corporate or government bonds. However, the risk is certainly higher.
It is important to know which company or companies are being invested in, and how much liquidity there is in the bond. Some platforms offer a secondary market where loans and loan parts can be sold off if the lender wants to exit a deal before the term time is up.
If this is important to you, make sure you only invest via bond platforms which offer exit clauses and with a good track record.
‘Pure’ P2P IFISAs
Traditionally, P2P lending meant exactly that – peers lending to peers. And there are still a few big platforms that do just this.
‘Pure’ P2P platforms generally offer lower returns of around 3-5 per cent, but they will also offer added security in the form of a provision fund or secondary market.
Consumer loans are generally vetted internally, making it more difficult for the average investor to do their own due diligence, which can be off-putting for some people.
However, these platforms tend to accept lower deposit amounts which can offset the risk factor somewhat.
Updated: Tuesday, November 27th, 2018