Frazer Fearnhead, chief executive and founder of The House Crowd, explains how an auto-invest IFISA could offer better returns with less risk
There are a wide variety of Innovative Finance ISAs on the market, enabling people to invest in consumer loans, business loans and asset-backed loans including property loans, held within a tax-free wrapper.
Like most peer-to-peer lending platforms, we offer both auto-invest and self-select products. However, we made the decision early on to only allow auto-invest products within the ISA wrapper and two years on, for the reasons below, we believe this was a sound decision.
P2P offers potentially good returns. However, there are risks involved and a property loan can go into default due to a mistake by a valuer, a mistake in securing the asset or because of fraud. All platforms have experienced these problems to a greater or lesser degree.
The target rate of return is, of course, important. But many people do not look beyond the headline rates, regardless of all the education and risk warnings we provide. It shouldn’t then be a surprise when a high-risk loan goes into default, but it usually is – especially to less experienced investors.
It should be obvious that a loan paying 10 per cent returns with a loan-to-value (LTV) of 75 per cent has a higher chance of going into default than one with an LTV of 50 per cent that pays five per cent interest. Unfortunately, many people do not take the sensible route of only putting a small amount of their capital into the higher-risk loans.
I am not a supporter of the nanny state and do not believe it is anyone’s right to dictate what adults do with their own money. People are free to make self-select investments with us if they wish via a standard account but with ISAs, we took the view that it’s just too important for people’s future financial security.
As a responsible platform, we therefore decided that we would enforce a degree of diversification for ISA investments so that a loss on one loan could likely be mitigated by target-beating rates on other loans in the portfolio.
We started with just one ISA product which is diversified across 15-20 loans at any one time but from January we will be offering three separate auto-invest funds, which can be invested in under the ISA wrapper.
People will now be able to select their own level of risk and reward by choosing Cautious, Standard or Adventurous accounts, or by spreading their money across all three for even greater diversification. Returns will range between five per cent and eight per cent depending on the loan criteria for each product.
Compounding, as every investor knows, is essential for maximising long-term returns and an auto-invest product does that best, with interest paid twice a year. If it is rolled up – especially in a tax-free wrapper – it will massively increase the size of your investment pot over a 25-year period.
Although the headline rates of some of our self-select investments are 10 per cent per annum, our calculations have found that investors’ money only tends to be earning interest around 75 per cent of the time. With an auto-invest product, it is working for you 365 days a year.
Furthermore, you will receive regular interest which can be rolled up, so, in all likelihood, the overall return would be better in auto-invest than self-select even before taking the tax-free consideration into account.