ISA season is upon us and investors have more options than ever before. Emily Perryman investigates the ISA transfer market and the role of the Innovative Finance ISA…
With interest rates on cash ISAs persistently low and pronounced volatility in stocks and shares, transferring to an Innovative Finance ISA (IFISA) can be an attractive option for many investors. Although there aren’t official figures on the total number of ISA transfers, data from the Financial Conduct Authority (FCA) shows IFISA subscriptions grew from 5,000 in 2016/17 to 31,000 in 2017/18, with the amount subscribed increasing from £36m to £290m.
Individual peer-to-peer lending platforms say transfers make up a sizeable chunk of the money placed into their IFISAs each year. At Ablrate, around 70 per cent of subscriptions come from ISA transfers with new money making up the remaining 30 per cent. At RateSetter, LendingCrowd and Relendex, transfers make up between one quarter and one third of subscription value.
The types of ISA being transferred into P2P lending platforms vary from one provider to another and are largely driven by investment risk. Ablrate, which sits towards the riskier end of the spectrum, only gets a few transfers from cash ISAs whereas the majority, around 60 per cent, are from stocks and shares ISAs and the remainder from other IFISAs
“I suspect those with cash ISAs are a little more cautious than most,” says Ablrate’s chief executive David Bradley-Ward. RateSetter, on the other hand, says around three quarters of its transfers come from cash ISAs. At LendingCrowd, cash ISAs account for approximately half of the volume and value of ISA transfers, while stocks and shares ISAs make up around 20 per cent of volume and 40 per cent of value.
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Best of both worlds The main driver for switching from a cash ISA to an IFISA is the higher interest rates on offer. No cash ISA on the market currently pays more than the rate of inflation, so money held in these accounts is actually falling in value in real terms. Even if a saver locked away their cash for five years, the best available rate of 1.6 per cent lags behind the Consumer Prices Index, which measured 1.8 per cent in January, according to data compiled by LendingCrowd.
Stocks and shares ISAs offer the potential for high returns but investors have to be comfortable with the stock market’s volatility, which can sometimes be extreme. Jonathan Minter, senior editor – financial services at Intelligent Partnership, says IFISAs can act as a middle ground between cash ISAs and stocks and shares ISAs. “An IFISA investment’s return will generally be fairly stable, or fixed, which makes it easier to predict returns. For some investors, this stability is worth the price of potentially higher gains,” he explains.
“Of course, for equity, P2P and debt-based securities investments, there is always the risk that investors could end up with less capital than they put in. I suspect many investors will be using an IFISA as a way of diversifying their portfolio with something truly different from the more traditional ISA options.”
Over the last 12 months, investors with portfolio/bond style IFISAs have earned around 5.75 per cent on their money, according to data from Relendex. “In contrast, although not directly comparable, stocks and shares ISAs experienced a significant period of volatility as world markets fell and those with cash ISAs earned an average of just 0.7 per cent from high street banks,” says Max Lehrain, managing director of Relendex.
Transfer considerations IFISAs can represent an attractive way of obtaining an above-inflation yield and smoother returns, but a transfer isn’t something to be taken lightly.
First off, investors need to be aware that they can only open one of each type of ISA each tax year. This means they need to be certain the IFISA meets their financial needs and goals and offers enough diversification. If an investor is transferring from a cash ISA, they also need to consider the additional risks involved. “The single biggest consideration for cash ISA investors is risk,” says Justin Modray, co-owner of Candid Financial Advice, an independent financial adviser.
“Whilst bank deposits may pay low rates of interest, they are safe, especially when within Financial Services Compensation Scheme (FSCS) limits. However, P2P lending losses are not covered by the FSCS, so if debts turn bad investors could lose money.
“Investors also need to take a view on the extent to which P2P lending returns would be hit by an economic downturn and the potential size of losses that could result in a bad case scenario. It’s important to weigh up potential returns with the risks involved.” Once an investor is sure a transfer is right for them, the process itself is fairly straight-forward. Investors complete a transfer form provided by the IFISA provider they want to move to, and the transfer should be carried out within 30 days.
Neil Faulkner, chief executive and head of research at P2P comparison site 4thWay, says P2P lending platforms are typically doing better than their counterparts in banking and equities when it comes to making transfers easier. “This is probably because most platforms count technology expertise and speed among their selling points,” he says. “Hold-ups typically comes from the other side.”
RateSetter and Relendex are both in the process of trying to make transfers more efficient. Relendex claims it is significantly investing in new platform technology with the aim of providing investors with an improved experience. RateSetter says it is going to speed up the process of transferring in a cash ISA and will announce more information in due course.
Meanwhile, Bradley-Ward says Ablrate’s transfer-in process is becoming more efficient, however many legacy providers still send cheques rather than carrying out a bank transfer, and this requires hard copy paperwork. “The process could be more digital on the whole and we are working towards encouraging this,” he says.
One thing investors need to be aware of is that transfers into an IFISA have to be done in cash, which means investments in a stocks and shares ISA must be sold before they can be transferred to the P2P platform. Existing P2P investors can also transfer their funds into an IFISA, but again this must be done in cash. This means investors have to sell their loan holdings, add the funds to the IFISA and then purchase loan parts within the wrapper. “There is an ‘open market’ requirement which can get frustrating for lenders, many of whom expect the platform to just convert their holdings from their standard account to their IFISA account,” says Bradley-Ward.
“Fortunately, we have a very efficient secondary market which makes the process easy – i.e. you can offer your loans from your standard account and buy them with your IFISA account.”
Appropriateness tests New regulations implemented by the FCA at the end of 2019 mean most P2P investors can only invest 10 per cent of their overall portfolio into P2P and they must pass an “appropriateness test” set by the platform. Faulkner says appropriateness tests make it harder for new investors to tap into the IFISA market, but only if they are unwilling to take the time to learn what they are doing.
Overall, most industry experts predict a temporary lull in transfers to IFISAs before a significant pick up in the future. “I think that after what is likely to be a brief slow down, transfers will pick up and exceed previous years,” says Faulkner.
“As more investors and financial advisers see the stable, solid returns available in P2P lending when investing in a sensibly diversified portfolio, P2P lending is going to be seen as a sensible place for substantial investment. It will help to better adjust the risk-reward balance of investors’ overall portfolios between safe but dreadfully poor performing savings versus the more volatile stock market.”
Roger Blears, founder and senior partner of law firm RW Blears, believes there will be a lot more transfers into IFISAs in the future because of the fragile nature of banks, which borrow short and lend long. “If, as seems likely, banks reign in their corporate lending for fear that productivity and profits fall because of the coronavirus, then the next financial crisis will not be pinned on sub-prime mortgages but on sub-prime companies which are having their bank facilities withdrawn,” he explains.
“This being the case, the opportunity to fund corporate credits with secured IFISA bonds will be attractive to investors.” Others reckon the new regulations have brought increased maturity to the P2P market, which will serve to increase consumer confidence.
As Minter says: “In this case, there is reason for optimism that the number of transfers into IFISAs will continue to grow, even if there is a stutter while the impact of recent changes takes effect.”