Having launched in 2022, the Innovative Finance ISA might be a relatively young product within the investment market, but it's one that is rapidly gaining interest and which looks to be filling a long-overlooked gap. Aiming to meet the requirements of both investors and borrowers, by means of a bond or peer-to-peer loan, investments held through the IFISA wrapper are used to provide loans to borrowers, often businesses in need of short-term capital.
While the investment raised will go towards numerous small business ventures, development finance is something by which bond investments held within IFISAs are making a big impact, with funds invested being utilised to help finance property projects. Being an industry where cashflow problems and overrun projects would be the norm, short-term finance is within high demand in the world of property development.
This – together with other commercial financial requirements – presents considerable possibilities to investors, provided it's met with a sensible approach. Knowing that, what is the scale from the chance of investors, how can they navigate through the risk and return landscape, and what's the larger picture for the investment itself?
Risk and return
Ansar Mahmood
The IFISA has been gaining momentum since its launch 3 years ago. In the 2022/18 tax year, six times more IFISAs were opened than the previous year, jumping from 5,000 to 31,000. This, no doubt, will have risen again significantly because the current tax year draws to a close.
The appeal of the IFISA is, mainly, because of its ability to offer investment products with high returns, while still allowing visitors to potentially receive an salary of up to lb20,000 tax-free. There's also IFISA investments available on the market that pay out to investors quarterly instead of annually, letting them take advantage of potential returns more frequently.
However, using the high rates comes a greater need for investors to consider sensibly about if they should invest through an IFISA. As with any form of investment, there is a risk with investing through IFISAs, and investments have no coverage through the Financial Services Compensation Scheme.
This risk can be mitigated, however, by steering clear of unscrupulous providers in the market, offering unrealistic and overambitious returns. In most cases, the higher the rate, the riskier the borrowed funds, and the more likely the borrower is to default. As a return rate, while still including risk, 6% is smart and realistic; 12% indicates very high risk.
Looking for providers that ensure all funds raised with an IFISA are asset-backed can also be a way of mitigating the risk of investment; regarded course, this isn't an assurance that capital will be repaid. Many IFISAs offer auto diversification, where the investment portfolio is diversified by lending to some number of different borrowers – again, assisting to mitigate risk.
Boosting the economy?
While investments through IFISAs offer investors a great roi, they might in addition have a much wider economic impact, by giving lending capital to businesses that are, in turn, working on projects that try to raise the UK economy. Investments through IFISAs create more flexibility within the lending industry and be sure, for instance, that business can access the short-term loans required to succeed. Additionally, it may give individuals access to credit they may not otherwise have been able to get it.
For property developers – often rejected by mainstream banks – it means they can access the capital necessary to deliver on much-needed residential developments. There is a lack of housing in the UK, and the Government-set target of 300,000 new homes each year has not yet been met.
We are seeing initiatives within the construction industry that seek to provide a solution to this housing shortage, that could have an affect on the home funding process. In social housing, for example, flat pack homes are starting to be built on a manufacturing line, where one unit may be put together within a week. This significantly reduces the usual time lags faced by developers, but more importantly, the risk to capital decreases as a result. If the production model was adopted in the private housing sector, it might assistance to meet the UK's housing demand.
This type of construction model would necessitate a general change in the way in which funding is perceived. Rather than property funding being seen as an lending process, it could be considered a cashflow process. For investors, the investment opportunity would remain – developers will always need use of funding. A transition to this type of model, however, can often mean investors get any returns quicker, as the shorter development time can lead to faster repayment of loans. It might also lessen the overall investment risk, because the holistic nature from the build means there is less scope for unforeseen challenges and financial hurdles that could place the whole project in danger.