How the Innovative Finance ISA can take off

As the alternative finance industry gears up for growth, exclusive research commissioned by AltFi demonstrates a remarkable lack of awareness for the

IFISA.

It is clear 2018 is the crunch year for the Innovative Finance ISA. Announced in March 2015, launched without any of the P2P world’s biggest names on the ticket in April 2016, and held back ever since as they kicked their heels awaiting authorisation, the moment has finally arrived when the stars are aligned.

The leading platforms are finally able to start promoting it in earnest – so what happens next? AltFi’s market-leading research has found clear appetite among P2P investors to use the new, tax-free wrapper – but almost no one else has even heard of it. The IFISA faces a major challenge to break through with investors and prove its worth.

A wall of public ignorance stands between the Innovative Finance ISA and mainstream adoption, however, with more than three quarters of people recently surveyed by saying they have never heard of the government-backed tax-free alternative investment wrapper.

Public awareness of the IFISA – announced by former Chancellor George Osborne in the 2015 Budget and formally launched in April 2016 – lags far behind P2P lending, which 60% of people told AltFi’s researchers they were familiar with.

The survey, which questioned just over 2000 adults leading up to Christmas, found that of those who had heard of the IFISA, about one in six had already put money into one (23% aware vs 4% who have invested). By comparison, roughly one in eight of the larger group who have heard of P2P lending say they have invested in it (53% aware vs 7% invested).

The higher conversion rate from awareness to adoption among IFISA users could represent early evidence that the opportunity to invest tax-free will encourage more people to put money into P2P loans and debt-based securities. But at this stage in the IFISA’s evolution, it might simply represent a rush among better-informed early adopters that will not necessarily spread into the wider market.

Age is a key factor in awareness of the IFISA and in people’s willingness to use it. Familiarity with the IFISA is significantly greater among younger people and they are at least three times more likely to invest in P2P and use an IFISA, according to the survey results. Some 15% of 18-34s say they already invest in P2P and 9% are using an IFISA: the equivalent figures for 35-54s are 5% and 3% respectively.

Very sharp regional and demographic divides also emerged from the survey. Awareness of the IFISA is strongly metropolitan, reaching 17% in Greater London, 12% around Birmingham and 10% in Edinburgh. But in Wales and the South-West almost no one has heard of it, and the picture is little better across most of northern England, Scotland and Northern Ireland.

Source: AltFi

Perhaps not surprisingly, people in the top socio-economic groups are most likely to be familiar with the IFISA. Some 18% of survey respondents in group A were aware, and about 10% of Bs, while among the C1, C2, D and E groups, the figure never climbs above 7%. In fact, the level of IFISA awareness is so low that the more detailed demographic and regional findings from the AltFi survey are based on sample sizes that are too small to be statistically robust – these figures should therefore be treated simply as a guide to the state of the market.

Do these results suggest that the IFISA is in danger of proving a damp squib? On the face of it, very low levels of awareness among the general public would seem to indicate a financial product struggling to gain traction, especially among the older age groups that have the most money to invest.

But in interviews with industry leaders and individual investors to delve into the snapshot provided by the survey, a picture emerges of a market that is in the earliest stages of development but is evolving gradually towards wider public adoption.

The IFISA’s roll-out so far

Since April 2016 almost 30 alternative lending platforms have launched IFISAs, offering P2P loans and debt-based securities, and targeting a mix of consumer, small business and property lending opportunities. At least three further platforms, RateSetter, ArchOver, and Thincats, have announced plans to launch IFISAs of their own in the coming months.

According to the most recent HMRC figures – disputed by some in the industry – about 2,000 IFISA accounts were opened during the 2016-17 tax year, attracting total “new money” subscriptions of £17m, or £8,500 per IFISA on average.

Over the same period, almost 2.6m Stocks & Shares ISAs received a total of just over £22.3bn in subscriptions – giving an average subscription of £8,623, very much in line with the average sum put into IFISAs. Our research found that about 13% of people say they have a Stocks & Shares ISA, while another 13% say they own shares or funds outside an ISA wrapper (although there is very likely to be some overlap between these two groups). 

AltFi’s survey results, which are not directly comparable to the HMRC figures due to timing differences, found that among those who had opened an IFISA, the average investment was around £4,450. People who had concentrated on P2P lending via their IFISA reported an average investment balance of almost £5,900. It is not clear why this discrepancy in the averages reported might arise. Could it result from a growing number of IFISA account openings since end of the 2016-17 tax year by younger people with less money to invest? 

During 2016-17, almost 8.5m Cash ISAs received total subscriptions of £39.19bn, a drop of nearly a third on the previous tax year, as a combination of rock-bottom interest rates and the introduction of the new personal savings tax allowance largely cancelled out the benefits of saving via Cash ISAs.

Another big influence on the scale of the early flows into IFISAs is regulation: platforms must achieve full authorization before they can register as ISA managers with HMRC. The three market-leading P2P platforms, Zopa, Funding Circle and Ratesetter, took longer to gain their FCA clearance than many small operators and were therefore late into this market.

Consumer lending platform Zopa was the first of the big three to be authorised, in May 2017, and launched its IFISA the following month. Funding Circle started offering its IFISA in November 2017 and Ratesetter is planning to launch in February 2018*.

Timing issues largely explain the IFISA’s low profile in its early stages. Given that platforms themselves are the providers of IFISAs, they will necessarily be the product’s main advocates. And taking into account the overwhelming share of retail investment flows into P2P lending claimed by the three biggest platforms, it is not surprising that in the period before the market leaders were able to launch their offers early take-up of the IFISA was slow and awareness of it extremely limited. By their nature, the smaller platforms have small pools of investors, modest revenues and therefore limited marketing budgets. Equally, the supply of opportunities to invest in P2P assets that they can offer represents only a very small slice of the overall market.

To give an idea of the potential change the arrival of the largest players could have on the IFISA market, the £17m subscribed into all IFISAs during the 2016-17 tax year should be set against the average of £36m per month invested in Funding Circle’s Classic account over the past six months. If Funding Circle’s investors follow the pattern already observed at Zopa and Abundance Generation, about half of that £36m per month can be expected to flow into IFISA accounts.

Does this therefore mean that now the leading P2P players are starting to roll out IFISAs, we can expect to see awareness and take-up surge? The signs are that take-up will rise, but conversations with leading industry figures suggest this will happen in carefully managed stages to ensure existing investors are not disadvantaged and that supply and demand for funds remain broadly in balance.

As Andrew Lawson, Chief Product Officer at Zopa, notes: “We have very much prioritised our existing customers when it comes to our IFISA, to ensure a balance between supply and demand [of funds].” Like Zopa, Funding Circle is so far promoting its IFISA only to existing investors. This staged approach will determine the way the IFISA market evolves over the coming year.

The key message is that this will continue to be a market sharply divided between a fairly small group of informed insiders and a much larger group of “P2P outsiders” who are likely to see relatively little mass marketing of the IFISA and among whom, therefore, awareness of it is likely to remain low. 

Baby steps towards mass-market adoption

The largest IFISA providers, Zopa and Funding Circle, are both taking an incremental approach towards the roll-out of tax-free P2P investing.

Zopa started last June by allowing its existing investors to open an IFISA and subscribe new money up to their annual allowance of £20,000 (a big increase from the £15,240 allowance in 2016-17, the first year the IFISA was available). In November, Funding Circle launched its Isa offering in a similar way, opening it first to new subscriptions from its most longstanding active investors (those who have made an investment in the previous six months), and also allowing them to sell existing portfolios of loans in its secondary market and move the funds into their IFISA account so they can re-invest tax-free. Once this group has had the chance to fund their IFISAs, Funding Circle will progressively open access for more of its retail investor base.

“Our hope is that we will be able to open up the ISA to all existing customers by the end of this tax year, and make it available to new customers next tax year,” the platform says.

Just before Christmas, Zopa took its next steps. First, it too started allowing existing IFISA holders to sell loans held outside their ISA and move the proceeds into the taxfree wrapper (up to the £20,000 ceiling) to invest in fresh loans. At the same time, the platform also began allowing investors to transfer funds from old Cash and Stocks & Shares ISAs into their IFISA, which Funding Circle does not currently permit.

Between them, these two developments are likely to be the crucial factors driving the next phase of growth in Zopa’s IFISA balances, and in all likelihood the growth of IFISA funds held by the other major platforms. Andrew Lawson says: “We’ve already seen really strong uptake and demand from people to transfer in old ISAs and we have to ensure that we focus on the quality of loans and supply to our current customers.”

The scale of the funds that could potentially flow on to P2P platforms as their existing investors transfer in old ISAs is very significant, and helps to explain the platforms’ caution.

Bruce Davis, Founder of Abundance Generation, which specialises in bonds backing renewable energy projects, says his platform sees its target market as about 8m UK adults with existing investments inside or outside ISA wrappers. This group holds historic ISAs containing about £100bn, he says.

To date, just over £20m has been put into the 2,337 IFISA accounts opened with Abundance since April 2016, of which £4.8m came via transfers-in of funds from existing ISAs held elsewhere.

For the moment, the big unknown, especially for the largest platforms looking to roll out the IFISA, is how keen their existing investors will be to transfer money over from old ISAs. “The scale of the transfer market then determines when we would start going out to new customers and promoting the IFISA,” says Andrew Lawson. “It’s somewhat dependent on how quickly we can serve all that transfer-in demand from our existing customers.”

Why the IFISA market will get deeper before it gets wider

The importance of ISA transfers highlights two major issues for P2P platforms as the tax-protected investment universe expands to take in the direct lending assets they specialise in.

The first is obvious, but worth spelling out. Now that P2P loans and debt-based securities can be held in an ISA wrapper, from the individual investor’s perspective they have effectively moved into a different “investment pot”, as Bruce Davis puts it. Before the IFISA, the money most investors put on to direct landing platforms would effectively have represented the amount left over after they had made their ISA commitments for that tax year. Now people can consider crowd bonds and P2P loans as part of their core ISA holdings, rather than just add-ons once the ISA money is committed.

Since opening its IFISA, Davis says Abundance’s average investment has gone from £7,500 to just over £10,000, and its typical fundraisings have grown from £1m-£2m to £4m-£5m. But this is not simply a result of ISA availability encouraging people to commit more money, he argues. “It’s a different pot of money and it’s about the size of the pot you’re talking to.” 

This shift has the potential to change fundamentally the way investors think about their P2P holdings and it opens up platforms’ access to a separate and much larger part of their existing investors’ portfolios – Davis believes Abundance’s “addressable pot” contains about £100bn that its owners would not previously have considered investing in P2P loans or crowd bonds.

The second major issue flows from the first, and is well illustrated by Zopa’s experience.

Between March 2017 and late January 2018, Zopa was closed to new investors, a move the platform took in order to ensure it could satisfy demand from its existing customers for P2P consumer loans, without having to take on more risk or drive down loan pricing. By the time it reopened to new investors, Zopa had a waiting list of about 26,000 people alongside its existing customer base of 60,000 investors.

“We’re seeing a lot of demand from existing customers to invest more in Peer-to-Peer,” says Lawson. The desire among Zopa’s investors to increase their P2P allocations means that the platform’s loan book is growing at nearly 50% year-on-year simply through the increasing commitments of its existing investors. As they start to transfer old ISA holdings into the platform’s IFISA, it is possible that Zopa will need to reinstate waiting lists from time to time to balance supply and demand on its platform.

The trend, therefore, that will shape the next phase of the IFISA’s roll-out is that the market is likely to get deeper – as existing P2P investors increase their allocation the asset class, both through new money and through ISA transfers – before it gets very much wider, with large numbers of new P2P investors joining the party.

Paul Sonabend, a VC investor who took out an IFISA with property platform Relendex in 2016, typifies this trend. He says that once the IFISA became available, a combination of growing confidence in P2P and the ability to invest taxfree encouraged him to channel his family’s money as well as his own into P2P. He has opened IFISA accounts for his wife and children, greatly expanding the overall sums he is prepared to commit.

Today, he has about 5% of his personal portfolio in P2P loans but as other investments mature and run off, he’s shifting funds over from other parts of his portfolio. “If you asked me again in 12 months, I would be very surprised if that proportion hadn’t doubled, and if all goes well in 10 years it could easily be 20% or 25%,” he says. It is this deepening of the P2P platforms’ relationships with their existing investors that will determine how quickly the IFISA can be extended to include the “P2P outsiders”.

Against this background, it is hardly surprising that for now awareness of IFISAs among the general public is so low. It is entirely possible that this will not change very much for some time to come.

Of course, the overall speed of the P2P market’s growth will determine how long it takes for the major platforms to absorb the pent-up demand from its existing investors with funds in other types of ISA. The faster the market grows the sooner these platforms will be able to market their IFISAs more widely to new customers. For smaller platforms that may find it harder to attract investor funds, particularly to back larger loans, the ability to receive ISA transfers could offer quicker access to a larger share of their investors’ overall assets, and therefore speed the growth of their loan books.

Who are the IFISA adopters and how much are they allocating?

Although AltFi’s research suggests that younger investors are slightly more likely to have heard of the IFISA than older consumers, and are significantly more likely to use it, interviews with several of the largest platforms do not suggest a major influx of younger investors into P2P since its launch. Andrew Lawson says Zopa’s investors are evenly distributed across the various age brackets, while Funding Circle’s investors are on average aged 50-plus.

Abundance Generation provides a useful insight into the profile of IFISA adopters that reinforces the impression of a product dominated so far by older, more experienced investors.

Bruce Davis, Abundance’s Founder, says the platform differs from others because rather than promoting its IFISA exclusively to existing investors, it advertised it to the mass market from launch in April 2016. “We’re probably the only one who’s gone out into the wider market and attracted new IFISA investors.” The result has been “quite a marked shift in the profile of investors who’ve come on to our platform,” he says. “We’ve still got our millennial audience putting in hundreds of pounds, but that just doesn’t move the needle in terms of the amounts of money. The people who move the needle put in £5,000, £10,000 and £20,000 investments and that’s a different group.”

The new arrivals have been better-off mainstream Stocks & Shares and Cash Isa investors predominantly in their fifties. These are not necessarily people primarily motivated by commitment to environmentally friendly investment – although they value the opportunity to support renewable energy projects. Instead, he says Abundance’s IFISA offers them a way to diversify their overall ISA portfolio and generate additional yield.

In terms of flows, both Zopa and Abundance say that about 50% of the new money placed on their platform is now going through IFISA accounts.

As far as allocations to P2P are concerned, Abundance says that 60% of its investors do not use any other platform, and the median portfolio allocation to Abundance is 10%, with a smaller group allocating up to twice that.

Bruce Davis believes this illustrates the role that direct lending platforms will come to play in mainstream retail investment portfolios, now that these assets can be included in ISAs. “The IFISA means the sector is now able to access larger pots of money, but we’re taking a similar share of those pots so we’re still a diversification play. I don’t think we’re stealing anyone’s lunch but it’s easier now to diversify your investments within the tax-free wrapper.”

The gulf that divides the IFISA market

For compelling practical reasons rooted in the need to balance supply and demand, the IFISA market is dominated by longstanding P2P investors who are using the new tax-free wrapper to increase their allocations to this asset class, often by transferring funds from other parts of their ISA portfolio and their existing P2P holdings. This process is likely to represent a significant proportion of IFISA inflows for at least the next few months and possibly longer. How ready are the “P2P outsiders” that form the great majority of our survey panel to take their initial steps into this market, and how many of them might eventually do so?

Some 26% of those who took part in the research own shares or funds either inside or outside an ISA, while 40% have a Cash Isa. Assuming the IFISA follows a similar trajectory over the next few years, perhaps 10%-20% of the population might eventually become P2P investors, inside or outside the IFISA wrapper. However, the rate of take-up will depend on numerous factors including how quickly alternative lending volumes expand and the outlook for interest rates on Cash ISAs, which could start to attract more money again if they began to rise.

But, as Karteek Patel, Chief Executive of Crowdstacker, argues, the major drag on wider adoption is likely to be the pervasive levels of ignorance about P2P. “Knowledge of alternative investing is still low and, by virtue of that fact, knowledge of the IFISA is still low,” he says. “But the people who are using the IFISA are reaping the benefits of it.”

The basic problem confirmed by the AltFi research is the continuing lack of basic awareness of P2P and the IFISA. This in turn feeds uncertainty and misconceptions about how these investments work – in many cases, the biggest group among respondents are the “don’t knows”. 

Most people are not sure whether the availability of an ISA wrapper makes P2P investing more attractive: 18% of people agree or strongly agree that it does; 14% disagree or strongly disagree; 27% neither agree nor disagree; 41% don’t know. It is noticeable here, though, that the 18-34 age group is more likely to agree with this statement than older respondents.

There is little evidence that people would prefer to spread their risks by investing across more than one alternative lending platform: again, 16% agree, 17% disagree, 26% are on the fence and 40% don’t know.

And in some cases, the survey responses directly contradict the attitudes of “P2P insiders” who are already familiar and comfortable with the asset class. Just 11% of people would consider transferring a Cash or Stocks & Shares ISA into an IFISA, while 33% of women and 43% of men regard lending their money directly to consumers and small companies as riskier than investing in shares. Just 12% in both cases regard it as a safer proposition. This finding, in particular, stands in direct contrast to the most recent UK market report from the Cambridge Centre for Alternative Finance, published in December. The CCAF conducted its research among active P2P investors and found that they consistently place alternative lending of various kinds below equities on the risk spectrum.

“We’re still a long way from the mass-adoption, mass-trust phase, where retail investors understand where alternative lending sits in a balanced portfolio,” says Karteek Patel of Crowdstacker.

One possible takeaway from these findings is that there is currently a group comprising about 10%-15% of the survey respondents, who have a reasonable understanding of the attractions and risks of alternative lending. Those in this group that are not currently using lending platforms are most likely to form the next wave of P2P adopters. This impression is reinforced by the evidence the survey reveals that people are keen to know more about alternative lending investments and are looking for information and advice: about 15% of respondents had seen a financial adviser in the past year and within that group, just over a quarter had discussed P2P lending with their adviser. Among 18-34-year-old respondents, 56% of those who had seen a financial adviser had discussed P2P.

The survey findings suggest that IFISA providers need to offer returns of at least 5% in order to get investors interested, and that a second hurdle exists at 8%, where another sizeable group of people indicate this level of return would encourage them to invest.

Source: AltFi 

Whether they will actually do so, however, remains a moot point. When asked whether they plan to invest more in 2018 than last year, the net balance in almost every age group is negative. The only exception to this comes among the 18-34s, among whom a net balance of 17% indicate that they do.

Overall, the research clearly demonstrates the widespread lack of knowledge about alternative investments that persists. There are some obvious bright spots in the findings for the long-term, notably the evidence that among younger people, P2P and alternative lending is well on the way to being regarded as a mainstream investment option. As they move through their peak earning years, those that choose to invest are likely to allocate a meaningful proportion of their capital to alternative lending assets.

But in the meantime there remains an unmistakable “wall of ignorance” that the IFISA must overcome before it can take its place alongside better known types of ISA in the portfolios of the wider investing public.

*Update: RateSetter launched its IFISA for existing customers on 8 February, as reported by AltFi.