The Innovative Finance ISA has obvious benefits for savvy investors but it has not yet reached its full potential. Kathryn Gaw asks what it will take to bring the tax wrapper to the masses…
It takes nerves of steel to be a stock market investor these days. Stock market portfolios have demonstrated extreme volatility in recent years, sending many investors towards the alternative credit sector in search of fixed, inflation beating returns. For the higher end of the wealth market, there is an array of investment opportunities in alternative credit. But for everyday investors the options are much more limited. Most private debt funds are squarely aimed at institutional investors only, and the few funds that are being marketed to wholesale investors tend to come with a minimum investment threshold of £50,000 or more. This leaves a substantial segment of the investing population adrift in the search for alternative sources of yield.
However, there is another option, which has a proven track record of delivering competitive, tax-free returns to investors with minimum investment thresholds as low as £5.
The Innovative Finance ISA (IFISA) was launched in April 2016 with the aim of encouraging retail investors to diversify their portfolios and back British businesses by funding peer-to-peer and crowdfunding loans. But despite its nine-year track record, and the stellar performance of the leading IFISA managers, the investment vehicle has still not taken off.
Read more: IFISAs offer steady returns amid stock market turmoil
According to the most recent HMRC ISA data, just 17,000 IFISA accounts were subscribed to during the 2022/23 financial year. By contrast, more than 3.8 million stocks and shares ISAs and 7.8 million cash ISAs were open during the same period.
HMRC estimated that the total value of the IFISA market in 2022/23 was £821m – a drop in the ocean when compared with the £47.1bn that was invested in stocks and shares ISAs that same year.
Meanwhile, according to data collated by the 4thWay P2P And Direct Lending (PADL) Index, IFISAs have been able to deliver much more consistent returns than the stock market, with average annualised returns for the sector outperforming inflation in nine out of the past 10 years. The PADL Index tracks the performance of six of the largest platforms in the P2P and direct lending space, all of whom are also IFISA managers. Last year, the index reported full year average annualised returns of 7.61 per cent for these IFISA managers. Over the past 10 years, the PADL constituents have earned their investors 7.31 per cent per annum annualised, net of investing costs and bad debts.
So what is holding the IFISA back from mainstream success?
“Despite the benefits of IFISAs, many investors remain unaware of the opportunities they offer,” says Hiran Patel, chief risk officer at IFISA manager Kuflink. “One way to improve accessibility would be for regulators and industry bodies to promote greater investor education about IFISAs and how they compare to traditional ISAs.”
Read more: Chancellor urged not to overlook IFISA in tax wrapper reforms
The IFISA sector was dealt a blow when the Financial Conduct Authority (FCA) issued a series of restrictions on P2P lenders in December 2019. These new rules included limiting platforms’ ability to market their products to retail investors, and making all incoming investors pass an appropriateness test before depositing their first funds. The FCA also advised that investors should not add more than 10 per cent of their investment portfolios into P2P loans, while P2P platforms were required to publish visible risk warnings on their websites and all promotional materials.
These rules stymied the sector’s growth, and created a costly administrative burden for platform managers, which led to several IFISA managers choosing to leave the space. A few months after these rules were introduced, the pandemic hit, causing investors to panic and withdraw their investments. This resulted in several more IFISA managers exiting the market.
Today, there are just 64 companies authorised to offer an IFISA, according to the HMRC’s ISA manager register. Yet at least 20 of these firms are either in administration or not open to new IFISA investments. That leaves approximately 40 players in the market, a mix of P2P lending platforms and wealth advisors.
Kuflink’s Patel believes that choosing the right IFISA manager represents a huge challenge to investors, especially considering the lack of publicly-available data and marketing information available. Awareness of the IFISA is still very low among retail investors, and even IFISA-aware investors have a mountain to climb before being able to make their first investments.
“For investors considering an IFISA, conducting thorough due diligence before selecting a provider is crucial,” says Patel. “Unlike traditional cash ISAs or stocks and shares ISAs, IFISAs involve lending to businesses or individuals, often through P2P platforms. While they offer higher potential returns, they also carry different risks.”
No two IFISAs are the same, which in itself creates an additional due diligence burden on the investor. As well as learning about the concept of the IFISA itself, investors are also required to investigate each IFISA provider thoroughly before making their choice.
IFISA managers run the gamut from property-backed P2P lending platforms and bridging lenders, to renewable energy funders and consumer lenders. What’s more, each of these platforms have their own minimum investment thresholds, ranging from £5 to £20,000. This will further limit the options for restricted retail investors.
“The first step in due diligence is to assess the provider’s track record,” says Patel. “Investors should look for platforms with several years of stable performance, rather than new entrants with a limited operating history. Platforms like Kuflink, which have been in the market since 2017 and have demonstrated reliability. Checking how long a provider has been operating, their past performance, and how they have handled defaults or financial downturns is essential.”
This information is available on the websites of each individual IFISA manager, as well as via third party ratings agencies such as 4thWay.
Risk management practices are another critical factor. Investors should examine default rates, how the provider conducts loan underwriting and due diligence, and what security is in place for the loans. Understanding the loan-to-value (LTV) ratios of the provider’s loans is also important. Platforms with conservative LTV ratios, typically below 75 per cent, offer a stronger buffer against borrower defaults. If a provider is offering loans with high LTVs or no collateral, it increases the potential risk to investor capital.
Transparency is another major consideration. A reputable IFISA provider will provide clear and detailed information on the loans being offered, borrower profiles, and how they have performed historically. If a provider does not disclose default rates, past performance data, or specific risk mitigation strategies, it could indicate a lack of transparency.
Finally, investors should assess the platform’s liquidity and exit options. Unlike other forms of ISAs, IFISAs are not inherently liquid, meaning investors may not be able to access their funds before the end of an investment term. Some providers offer a secondary market, where investors can sell their investments early, but the existence of a secondary market is no guarantee of a sale. For instance, during the pandemic, some secondary market transactions took months to complete, while even under good market conditions loan sales can take several weeks.
Choosing an IFISA provider may take some research but the rewards are clear.
“The assets underpinning IFISAs have been around since at least 2005 and the investing performance has been exceptionally good and very stable,” explains Neil Faulkner, managing director of 4thWay.
“Net returns between 5.5 and eight per cent every single year, even through major recessions, pandemics and high inflation, surely will have to earn the curiosity of many millions of savers and investors in the long run.
“The fact that the actual results have not been sufficient to push IFISAs into the mainstream suggests that the right set of luck and circumstances for this to happen simply haven’t happened yet.”
Last year, the IFISA rules were updated to remove a previous restriction which meant that investors could only open one new IFISA account per year. Faulkner hopes this will help to encourage investors to diversify across more providers’ loans, but he is not convinced that this will bring a flood of new IFISA investors into the market.
Last year’s update also extended the remit of the IFISA, bringing open-ended property funds and long term asset funds (LTAFs) under the scope of the IFISA for the first time.
Since then, a handful of brokers and investment managers have entered the space, although at the time of writing, no LTAF provider had yet received IFISA manager status. One LTAF provider told Alternative Credit Investor that it had no plans to apply for IFISA manager status as its LTAF investors were exclusively institutional.
However, it is just a matter of time before the first LTAF or open-ended property fund manager starts to target the restricted retail market and decides to offer IFISA-wrapped products.
“This shift is undoubtedly creating more competition in the alternative investment space,” says Patel. “However, we see this as an opportunity rather than a threat. Competition is a natural part of a growing financial sector, and ultimately, it benefits investors by providing more choice and better transparency.”
Read more: How to invest in an IFISA in 2025
Both Patel and Faulkner believe that more could be done to encourage investors to consider IFISAs. Faulkner has been openly critical of the regulator’s “absurdly cautious approach”, which he believes is overweight on liquidity risk and underweight on volatility risk.
“[The FCA] does not seem to realise that a huge number of investors would be perfectly willing to accept that their investments might be tied up for a bit longer, if it means not all of their holdings are subject to the rollercoaster of the stock market,” Faulkner adds.
Meanwhile, Patel suggests that streamlining the ISA transfer process would make it easier for investors to move funds from low-interest cash ISAs into higher-yielding IFISA options.
Alternative Credit Investor has been covering the IFISA market since 2016 and in that time has reported extensively on the slow growth of the IFISA, and the consistency of the performance of the largest IFISA managers, most of whom have been operational for more than six years with a zero-capital loss record.
These platforms have weathered some incredibly testing economic and regulatory challenges, and continue to offer risk-managed returns of more than seven per cent per year. Perhaps the small size of the IFISA market has enabled this sustainable growth, but as the IFISA segment evolves, investors will have to remain engaged and be prepared to do their own homework in order to reap the obvious benefits of this investment opportunity.
