Uptake on the new Innovative Finance ISA (IFISA) has been slow, but that’s not to say its future isn’t bright
by Andrew Davis
When stats for the first year of subscriptions to the new Innovative Finance ISA (IFISA) were published last summer, there was nothing in them to suggest the mainstream investment sector ought to pay attention. Just 2,000 of the new ISAs were funded in the first 12 months, the subscriptions totalling £17m. To put that in context, over £22.3bn flowed into stocks and shares ISAs in 2016–2017, some 2.6 million of which received subscriptions.
Although the 2017–2018 IFISA numbers will be larger, they will still look tiny next to the established types of ISA, reinforcing the temptation among most advisers and asset managers to write off IFISAs – and the peer-to-peer loans and debt-based securities they contain – as a DIY investor fad that the sector can afford to ignore. It’s easy to understand this view. Beyond a core of more adventurous DIY investors, public awareness of these products is extremely limited.
Research exclusively commissioned by AltFI finds that less than one in four people have even heard of IFISAs (although 60% are aware of P2P lending). Besides, new and unorthodox investments like these are tricky for advisers to handle even if they want to. Suitability and compliance are headaches, and professional indemnity insurance may well not extend to areas like P2P lending.
For many in the sector, P2P lending and IFISAs remain largely irrelevant. However, some take a different view, and if you peer a little harder under the bonnet, you can see why they believe that we are witnessing the start of something potentially quite big. First, it’s worth understanding why the take-up figures so far for IFISAs has been so underwhelming. Although there are now more than 30 providers, most are minuscule. The largest P2P companies (Zopa, Ratesetter and Funding Circle) were unable to offer IFISAs from the start, in April 2016, because they were still awaiting authorisation by the FCA, a precondition of becoming an ISA manager. The big three, accounting for around 80% of lending between them, are now authorised, so we can expect the marketing to ramp up considerably from here.
P2P lending is just a new way of carrying on an activity that is as old as the hills: direct lending, as opposed to bank lending
It’s also worth noting that P2P lending volumes continue to grow fast. According to
AltFi Data, the 2017 UK total is about £5.2bn, up 37% on 2016. It believes growth will accelerate in 2018 to 43%, lifting total lending to £7.5bn. One more year like that and we’ll have a £10bn-plus market, although not all of it will be funded by retail money since institutions are becoming steadily more active in P2P.
This should not come as a surprise. P2P lending is just a new way of carrying on an activity that is as old as the hills: direct lending, as opposed to bank lending. Certain specialist types of borrowing have long been the preserve of non-bank direct lenders – property-bridging loans for example. All that’s happened in recent years is that tech-savvy financial entrepreneurs have found ways to open up a range of direct lending markets to people who could not previously access them. They’ve been helped by tougher post-crisis regulation of banks that has encouraged them to pull back from certain markets, and more recently by initiatives such as Open Banking, which will make it easy for non-bank lenders to access borrowers’ bank account histories to help speed up credit assessments.
Niche asset managers such as Octopus and Downing have concluded that the P2P and debt-based securities market is one with long-term potential and are building their direct lending offering. Octopus is working hard to expand awareness among financial advisers for its Octopus Choice P2P operation, which offers the opportunity to invest in property-backed loans originated by a sister company, Octopus Property. At an event in January, Sam Handfield-Jones, director of Octopus Choice, says the business had already signed up about 750 financial advisers and was adding 50 to 60 a month. The bet these asset managers are making is that over the long term, P2P loans could become an established part of the adviser’s armoury and take their place in many wealthier investors’ portfolios.
I suspect they’re right. According to the Barclays Equity Gilt Study 2017, UK equities made a real return of 2.5% a year over the decade to 2016, and 3.7% a year over the 20 years to 2016, in both cases with significant volatility. Time will tell, but it’s not impossible that a well-diversified basket of loans could make real returns in that range over similar time horizons with far less volatility.
And if that prompts some to think again about this asset class, another factor might also help. Anecdotal evidence from the major P2P providers suggests that many of the ISA transfers they are now accepting come from investors’ existing Cash ISA holdings. To my mind, this is why the investment sector should be watching this area closely – cash ISAs have never been part of their world, but IFISAs could be.