Peer-to-peer lending

Has the new Innovative Finance ISA caught your eye yet? Despite going live on 5 April, this new version of the tax-free individual savings account got rather lost in the reporting over the ISA changes announced in the Budget, including next year’s launch of Lifetime ISAs.

For the uninitiated, Innovative Finance ISAs enable you to hold a portfolio of peer-to-peer loans, available through online platforms such as Zopa, Funding Circle and Ratesetter, and to shelter the interest they generate from tax. The concept is pretty appealing given that such portfolios may deliver interest of 6 per cent a year or more – more than 10 times as much as the typical cash ISA.

Peer-to-peer? Think investment company

Here’s the thing though. Even before 5 April, it was possible to invest in the peer-to-peer lending sector through an investment company – and not only are shares in such funds allowed within an ISA, the funds also offer professionally managed exposure to these assets.

That’s important because for all the hype about peer-to-peer lending, this is a relatively new type of investment. Some in financial services – including the former City regulator Lord Turner – believe peer-to-peer lending may come a cropper if the economy takes a nosedive and people struggle to repay the loans they’ve taken out. Even leaving aside that fear, very few people have lots of experience in investing in peer-to-peer finance.

“It’s hard work to put together a diversified portfolio for yourself,” warns James Cardew, research director at the analyst QuotedData, explaining why investment companies in the sector - including P2P Global Investments, VPC Speciality Lending, GLI Alternative Finance, Funding Circle SME Income, Honeycomb Investment Trust and Ranger Direct Lending – have been popular over the past couple of years, successfully raising hundreds of millions of pounds in the market.

That’s not to say these funds are exactly analogous to the peer-to-peer loan portfolios that will sit in people’s Innovative Finance ISAs. For one thing, they each buy a range of different types of asset, including loans to small companies and international loans. More fundamentally, these funds are stock-market listed vehicles, with shares that rise and fall over time, whereas the Innovative Finance ISA is a portfolio of loans.

All about the income

Nevertheless, the quoted investment companies in this area will be appealing to investors looking for income – the same audience as Innovative Finance ISAs are courting. All the funds mentioned above are targeting yields of between 6 and 10 per cent a year. In the current low interest rate environment, that looks tremendously exciting.

It doesn’t have to be one thing or the other, of course. The ISA rules are sufficiently flexible to enable people to try both approaches at the same time – perhaps dipping their toes into direct investment while relying on managed exposure for the bulk of their exposure to these assets.

However, if you’re nervous about peer-to-peer lending and don’t feel comfortable with the answers to questions such as “Who am I lending to?”, “Is my risk diversified?”, and “What sort of safety net is in place”, a professionally-managed route into the sector may be a good option.

Investment companies offer that approach in a way that would be difficult for an open-ended fund, which grows and shrinks in size as investors buy and sell their units and therefore struggles with less liquid asset classes such as these.