Risk and The Innovative Finance ISA

By Mike Baliman on Tuesday 14 July 2015

Opinion

With a combination of a following political wind and slow-and-steady public sector consultation the “3rd ISA” is just over the horizon.  Well that’s if your horizon goes into the next tax year.

But how risky is Alternative Finance?

It’s very hard to tell in an industry which has so far focused on the “origination” side of the equation – sourcing enough deals to feed the ravenous tech-like appetite for exponential growth.  The “sell” side – passing it on to punters like you and I or increasingly institutions including funds investing in the assets – has been more neglected.

Before you make any investment you need a feel at least for what the risk is.

In a cash ISA, as long as you chose a deposit-insured bank (hard not to) you are covered well above the annual ISA amount.

In an equity ISA – well your “stress test” is as good as mine.  No place for short term funds – there have been more than enough equity market crashes in my lifetime.  However longer term there is a different risk … the risk that inflation gradually erodes your capital.  At this point mainstream equities become less of a risk and more of a match than cash.

So don’t stick your flat deposit money in equities but do stick graduation funds for your newly born grandchildren in equities.

So far so good.

But how does this extend to the Alternative Finance fixed interest and equity world?

What precisely will be allowed is yet to be seen.  And indeed certain asset classes – most notably crowdfunded equities are far too young to have any track record anyway.

Anyway why should you have to do all the hard work?  You are the buyer, not the seller.

In such new asset classes it seems axiomatic to me that the sellers, the platforms have an onus on them to tell you how much risk you are taking.

Equity platforms do do that.  They include the derriere-covering, regulatory approved statement that you might lose all your money.  Right that’s clear then – not a long term investment for grandchildren.  But – we presume in the absence of evidence otherwise – a position as a bit of “sex on the side” for an otherwise dull overall portfolio invested in mainstream asset classes.

As to online lending/borrowing the picture is less obvious.  Performances to date of most of the big players has been well above cash rates and with so far less risk.  So prima facie – and this is how folks seem to treat it right now – if you are a tad racey you can use it to increase the yield on your cash-like assets (as long as you stick to low risk, short-maturity).

But how do you – or anyone else – compare one P2P player with another?

Of those platforms with provision funds which is the safest?  Which is the riskiest?

Of those platforms which grade their assets by their measure of risk which do it best, which do it worst?

It seems to me there is no information at present, let alone independently audited/verified/produced which will enable you to make a rational assessment of the risk level you are taking with the various platforms.

Let’s hope the industry fills this gap sooner rather than later.  Otherwise the market will end up investing in platforms whose adverts they like.

#TwasEverThus?

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