With the tax year drawing to a close, there’s been a renewed interest in Innovative Finance ISAs (IFISAs).
IFISAs allow you to utilise your tax-free allowance while investing in a range of peer-to-peer (P2P) products as well as debentures and mini-bonds – more on mini-bonds in a moment. At Zopa, we provide IFISAs which invest in consumer loans (it’s a market we know really well, with more than 14 years of experience). There are other IFISA providers out there that invest in different areas, such as property or businesses.
It’s really important investors know exactly where their money is being invested, what the operating model of the platform is, and how they manage risks.
In this piece, we take a closer look at the different types of investments that can be included in an IFISA.
What’s a P2P investment?
P2P involves investors extending loans to borrowers or businesses and making returns on the interest when repayments are made. P2P platforms use technology to connect people looking to invest money, with people looking to borrow.
Different platforms have slightly different models. Some will allow you to pick and choose who you invest in, and even pick your price, this can be very risky, with all your money concentrated into a small number of loans, and requires a really good understanding of the risk to be able to set prices.
At Zopa, we only lend to low risk “prime” people, never companies. It’s a big market, and there’s a lot of data, that helps us make decisions on borrowing criteria, and how we expect loans to perform. We also like prime consumer loans, because (whilst not immune) they tend to be a bit more stable through economic upswings and downturns than some other investments. In addition to all this, we manage our customers’ risk by ensuring that their money is spread across many loans. This diversification of investor money across a large number of different loans is an excellent way to reduce the risk.
Mini-bonds can fall under the IFISA umbrella but they are different to other P2P investments. That difference matters. Here’s why:
What’s a mini-bond?
Mini-bonds can sound similar to established P2P offerings, but they should not be confused. IFISAs that deal in mini-bonds often allocate the whole of an investment to one business. In these cases, the risk is concentrated in one company. If that goes bust, big losses can follow.
And that’s not all.
Breaking down the differences
First and foremost, most mini-bonds are not actually IFISA eligible. Only a very small proportion of existing IFISAs will include mini-bonds.
There are big differences in the risk associated with each product. Mini-bonds tend to be viewed as riskier than P2P. One reason for this is that they normally involve investing in one company, so if that firm goes bust the whole investment could be jeopardised.
At Zopa, and some other P2P platforms, no single borrower holds all of an investment. We break our investors’ money down into small chunks and spread that across different loans. Although one loan may default, an investor should have lots of other healthy ones to cover this loss. We also factor predicted defaults in when projecting returns.
The P2P industry has an established regulatory and supervisory framework which companies like Zopa must adhere to. We also have contingency plans that protect our investors’ money should we run into trouble.
On the other hand, mini-bonds are currently largely unregulated currently.
Mini-bonds are usually fixed, meaning investors are locked in for the full term and cannot access their money early if they want or need to.
That’s not the case with most diversified P2P platforms. For example, at Zopa we have secondary markets. This means that if an investor wants to access their money as a lump sum, they can sell their loans with a 1% sell fee, as long as there are other buyers in the market.
Mini-bonds are a relatively new product. As with anything that’s less tried and tested, there is more chance that unforeseen circumstances could arise.
Many P2P platforms, including Zopa, have a strong track record of managing risk. We’ve delivered positive returns on our platform in each of our 14 years of lending, take a look here.