What returns should you expect from your IFISA?
Innovative Finance ISAs (IFISAs) offer some of the most attractive returns on the market. But there can be a massive difference in the rates offered between the various IFISA managers.
At the time of writing, the lowest IFISA returns ranged from around three per cent to over 15 per cent – all tax free.
So why are some IFISAs able to offer higher returns than others?
There are several factors at work. In most cases, IFISA investments abide by the ‘high risk, high reward’ rule, which means that while three per cent may seem low compared with other IFISAs, the risk level may be closer to that of a Cash ISA.
IFISA returns are driven by loan demand and by risk. There will naturally be less demand for prime central London (PCL) property loans, for instance, than there will be for short-term consumer loans. This goes some way towards explaining why Zopa’s consumer-focused ISA Core product targets returns of 4.5 per cent, while PCL-facing P2P lender CapitalRise offers average IFISA returns of around ten per cent.
Each IFISA provider will have their own way of measuring risk and setting target returns, and these processes will be explained to investors in some detail on their websites. Understanding the risk measurement process is essential for any IFISA investor, and should form a key part of your personal due diligence. However, it is also possible to loosely categorise IFISA returns by sector, as we shall see below…
Average returns by sector
- Average returns: 3-16 per cent
Peer-to-peer (P2P) property loans run the gamut from low-paying yet secured buy-to-let (BTL) IFISAs, to higher-risk development property projects, which usually target double figures for investors.
There are significant differences between the various types of property IFISA. The BTL market is established and stable, with a surplus of great borrowers. By contrast, property development is a notoriously volatile industry, as loan returns can be impacted by any number of delays or difficulties on site, and there is always a chance that the project could fall apart completely.
In the middle of the risk spectrum is residential property loans (de facto mortgages) and commercial property loans. These IFISAs tend to offer returns of between five and eight per cent, and the risk is generally offset against a first-charge security on the property, which will help investors to recoup their capital in the case of a default.
Property IFISAs are so variable that it is impossible to compare one offering with another, without first accounting for the risk involved and the procedures that can be put in place if a loan goes bad.
- Average returns: 3-15 per cent
Green IFISAs have become increasingly popular recently, as investors seek to earn a decent return while also doing some good in the world. But since the UK government shut down its wind farm subsidiaries programme, green IFISAs have become a little more risky. This risk is reflected in the eye-popping returns that are offered for construction or development projects.
A recent influx of ethical crowd bonds have allowed IFISA providers to offer higher-value, longer-term bond products which offer at least three per cent per annum for income-seeking investors.
SME LENDING IFISAS
- Average returns: 4-15 per cent
Small and medium sized businesses have struggled to win bank funding post-financial crisis, and so it is little surprise that P2P lenders have jumped in to fill this funding gap. SME loans are arguably the most popular products offered by IFISA providers, and they can vary from short-term bridging loans, to long-term growth funding.
Always check whether your SME loan is secured or unsecured – as a general rule, unsecured loans will offer higher target returns, but in the case of a default it may be hard to get your money back. Secured business loans usually take collateral in the form of an asset or property share.
CONSUMER LENDING IFISAS
- Average returns: 3-6 per cent
P2P platforms began by offering peer-funded loans to consumers who were unable to get reasonably-priced loans elsewhere. Consumer loans still make up a huge part of the P2P market, and there are plenty of IFISAs focused on consumer lending. However, consumer borrowers are primarily attracted to P2P lenders because of their competitive rates, which means that the target returns for investors are also on the low side.
Consumer loans can also carry a variable level of risk, so once again due diligence is essential before any money is invested.
Updated: Tuesday, June 4th, 2019