Innovative Finance ISAs: the building blocks for good investment?
Having launched in 2016, the Innovative Finance ISA (IFISA) might be a relatively young product in the investment market, but it is one that is rapidly gaining popularity and which looks to be filling a long-overlooked gap. Aiming to meet the needs of both investors and borrowers, in the form of a bond or peer-to-peer loan, investments held through the IFISA wrapper are used to provide loans to borrowers, often businesses in need of short-term capital.
While the investment raised can go towards numerous business ventures, development finance is one area in which bond investments held within IFISAs are making a big impact, with funds invested being utilised to help finance property projects. As an industry where cashflow problems and overrun projects are the norm, short-term finance is in high demand in the world of property development.
This – together with other commercial financial requirements – presents considerable opportunities to investors, provided it is met with a sensible approach. With that in mind, what exactly is the scale of the opportunity for investors, how do they navigate through the risk and return landscape, and what is the bigger picture for the investment itself?
Risk and return
The IFISA has been gaining momentum since its launch three years ago. In the 2017/18 tax year, six times more IFISAs were opened than the previous year, jumping from 5,000 to 31,000. This, no doubt, will have risen again significantly as the current tax year draws to a close.
The appeal of the IFISA is, in large part, due to its ability to offer investment products with high returns, while still allowing individuals to potentially receive an income of up to £20,000 tax-free. There are also IFISA investments on the market that pay out to investors quarterly rather than annually, allowing them to benefit from potential returns more regularly.
However, with the high rates comes a greater need for investors to think sensibly about if they should invest through an IFISA. As with any form of investment, there is a risk with investing through IFISAs, and investments are not covered by the Financial Services Compensation Scheme.
This risk can be mitigated, however, by steering clear of unscrupulous providers in the market, offering unrealistic and overambitious returns on investment. Generally speaking, the higher the rate, the riskier the loan, and the more likely the borrower is to default. As a return rate, while still including risk, 6% is sensible and realistic; 12% indicates extremely high risk.
Looking for providers that ensure all funds raised via an IFISA are asset-backed can also be a means of mitigating the risk of investment; though of course, this is not a guarantee that all capital will be repaid. Many IFISAs also offer auto diversification, where the investment portfolio is diversified by lending to a number of different borrowers – again, helping to mitigate risk.
Boosting the economy?
While investments through IFISAs offer investors a good return on investment, they could also have a much wider economic impact, by providing lending capital to businesses which are, in turn, working on projects that aim to boost the UK economy. Investments through IFISAs create more flexibility in the lending industry and ensure, for example, that business can access the short-term loans needed to succeed. It can also give individuals access to credit they may not otherwise have been able to get it.
For property developers – often rejected by mainstream banks – it means they can access the capital required to deliver on much-needed residential developments. There is a shortage of housing in the UK, and the Government-set target of 300,000 new homes per year has yet to be met.
We are seeing initiatives in the construction industry that seek to provide a solution to this housing shortage, which could have an impact on the property funding process. In social housing, for example, flat pack homes are beginning to be built on a manufacturing line, where one unit can be put together in as little as a week. This significantly reduces the usual time lags faced by developers, but more importantly, the risk to capital decreases as a result. If this production model was adopted in the private housing sector, it could help to meet the UK’s housing demand.
This type of construction model would necessitate a change in the way funding is perceived. Rather than property funding being seen as a lending process, it could be viewed as a cashflow process. For investors, the investment opportunity would remain – developers will always need access to funding. A transition to this kind of model, however, could mean investors receive any returns quicker, as the shorter development time could lead to faster repayment of loans. It could also reduce the overall investment risk, as the holistic nature of the build means there is less scope for unforeseen challenges and financial hurdles that could put the whole project at risk.
Investments through Innovative Finance ISAs could be a win-win for investors and borrowers alike, acting as a bridge between the two. While investors could see healthy returns at a high rate, borrowers can access funding to fuel projects across the UK which could boost the economy. These bridging loans could even help to address national problems such as the housing crisis, through aiding property financing. Investors do need to approach the opportunity with some caution, however. In an area where there will always be risk, opting for an IFISA with a sensible rate – rather than a flashy one – could pay dividends.
Ansar Mahmood is the founder of Fluid Bond, an Innovative Finance ISA eligible bond product