Innovative-finance Isas (IF Isas) allow investors to put money into alternative investments, such as peer-to-peer (P2P) loans, property crowdfunding, or alternative-energy schemes. The interest earned on loans is free of income tax, while any sales of loans within the Isa wrapper will not incur capital-gains tax.
IF Isas were introduced in 2016 and met with little enthusiasm. Providers had to be approved by HMRC and the FCA, which proved a protracted process. Today there are plenty to choose from, but they are still a niche product and take-up is low. By August 2018 the latest official figures available just 31,000 IF Isas had been opened, with £290m invested. This compares with 7.7 million cash Isas with £39.8bn invested, and 2.8 million stocks and shares Isas containing £28.7bn. Even lifetime Isas outstrip IF Isas: 166,000 accounts with £570m.
IF Isas come in many different forms. The two main types contain property loans and loans to small and medium-sized businesses. But you can also put your money into personal loans, renewable-energy projects, film finance, and micro-finance in Africa.
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In a world where you can barely get the rate of inflation back on your cash Isa savings, the headline rates on IF Isas can look very tempting. You don't have to look far to find advertised rates of between 5% and 8%. Even 15% is on offer.
But IF Isas are hardly risk-free. Some IF Isa providers are touting their accounts as alternatives to cash Isas. They are nothing of the sort. There's a reason you're being wooed with such high rates: these are risky investments, not least because the markets they represent are far from one-way bets. Putting your money in bricks and mortar is all very well when property prices have been shooting up as they have been for a decade now. But with prices now beginning to slide, you could easily find your investment shrinking. It's a similar story with lending to small businesses. It's all well and good if the economy is growing and people are spending. But when the downturn arrives, smaller businesses will default on their loans or go bust.
Liquidity is a problem too. You may be happy tying your money up for up to five years, but what if you need access to it quickly? With a cash Isa, you may have to give notice, but you can always withdraw your funds and, at worst, suffer a loss of interest. And you can sell stocks and shares relatively quickly, even if you may not get back what you paid for them. With IF Isas, secondary markets can be very limited and you may not be able to get your money out at all. When things turn ugly, you could struggle to sell your investment before its value falls to zero.
None of the peer-to-peer (P2P) lending platforms (except Zopa, which was launched in the UK in 2005) have lived through a downturn; it remains to be seen how they would handle it. Many do offer a safety net, such as a contingency or reserve fund. But once the defaults start, these may not provide enough protection. You should also be aware that these investments are not covered by the Financial Services Compensation Scheme.
One of the biggest failings of IF Isas, however, is a lack of diversification. Platforms tend to specialise in one form of finance. And while you can bundle your loans up so that you're investing in multiple small businesses, for example, it can be difficult to spread your investments around between property, small businesses and renewable energy. On the plus side, there are currently two platforms that do offer a diversified IF Isa (see box).
The upshot is that an adventurous investor should certainly consider putting a small amount of money into IF Isas an amount that they wouldn't mind forfeiting should things go wrong. We look at some of the more interesting options in the box on the left.
Where to look now
If you want to lend to individuals, RateSetter, one of the biggest P2P platforms (which also lends to SMEs), offers 3.4%-5.9%; interest rates at Zopa range from 4.5% to 5.2%. LendingWorks offers up to 6.5%.
Among lenders to small and medium-sized businesses, Assetz Capital is the biggest player and targets a return of 4.1%. ThinCats claims "typical" interest rates of 7%-15%, before fees of 1% and 4% and defaults. Folk2Folk claims a return of 9%.
Property is a big sector in P2P lending.Landbayis one of the bigger players and lends to buy-to-let investors, targeting a return of 3.25%; Octopus Choice has a target rate of 4%. For those interested in renewable-energy projects, Abundance Investments is offering up to 10% a year. Triodos Bank is aiming for up to 7% on energy and community projects. And Lendahand allows you to invest in solar-energy projects in Africa with a projected return of 6.75%.
Just Isa specialises in litigation finance, funding "carefully selected" cases for people who may not be able to afford to take their grievance to court. It offers an 8% return.
If you want to spread risk and diversify your investments, you have two options. Goji Investments' IF Isa allows you to invest across multiple platforms, with a target return of 5%. However, it is expensive 0.95% a year. At Orca Investments your money is spread across five platforms LendingWorks, Assetz, Octopus Choice, Landbay and LendingCrowd offering consumer, business and property loans returning between 4.3% and 5.3%. Orca will charge 0.65% after April 2020. For more IF Isa ideas, see moneyweek.com.
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Ben studied modern languages at London University's Queen Mary College. After dabbling unhappily in local government finance for a while, he went to work for The Scotsman newspaper in Edinburgh. The launch of the paper's website, scotsman.com, in the early years of the dotcom craze, saw Ben move online to manage the Business and Motors channels before becoming deputy editor with responsibility for all aspects of online production for The Scotsman, Scotland on Sunday and the Edinburgh Evening News websites, along with the papers' Edinburgh Festivals website.
Ben joined MoneyWeek as website editor in 2008, just as the Great Financial Crisis was brewing. He has written extensively for the website and magazine, with a particular emphasis on alternative finance and fintech, including blockchain and bitcoin.
As an early adopter of bitcoin, Ben bought when the price was under $200, but went on to spend it all on foolish fripperies.
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