Are Innovative Finance ISAs as bad as they are painted?
When George Osborn, then Chancellor of the Exchequer, announced the launch of Innovative Finance ISAs (IFISAs) back in 2016 there was much hype about how they would be an exciting new way to invest, bringing investments previously only open to the ultra high net-worth investor to the ordinary investor. Invested money is used by the fund managers to invest in highly fashionable areas such as mini-bonds (loans to companies that pay high interest rates as they can’t easily access the funding required through more mainstream suppliers) or peer-to-peer investments.
However, the recent collapse of London Capital& Finance has resulted in the financial watchdog – The Financial Conduct Authority (FCA) – issuing a warning about these products. In fact, the warning is more around taking careful note over how the IFISA is marketed rather than the IFISA itself, which is no more (or less) risky than it was when it was first launched.
Key points from the FCA’s warning include:
Although IFISAs are generally high-risk, some firms are marketing them alongside cash ISAs.
The investments may not be protected by the Financial Service Compensation Scheme (FSCS) so customers may lose the money invested if their provider fails
This is not the first time that the FCA has shown its concerns in this area, back In December 2018 the FCA instructed one provider to withdraw all of its marketing literature because it appeared to suggest that IFISAs were somehow similar to cash ISAs. The FCA’s concerns then centred on the marketing material (‘promotions’) used by the provider and included:
Warnings within the promotions that the underlying investments were not covered by the FSCS and were not themselves regulated by the FCA were given much less prominence than the statement about the firm being authorised and regulated by the FCA
The statement within the promotion “LOOKING FOR HIGHER RETURNS THAN THE HIGH STREET” was given higher prominence than the balancing statement, which was “Investing in bonds means your capital is at risk and payments are not guaranteed if borrowers default”
While the firm itself was authorised by the FCA, the specific activity of issuing mini-bonds is not a regulated activity. Mini-bonds, at first glance, may seem to be the same as corporate bonds which have a long track record within unit trusts and OEICs as lower risk investments. But unlike corporate bonds, mini-bonds are not traded on any exchange and must be held until maturity.
These types of investment cannot be considered to be risk free, or even low risk as the loans are typically unsecured and the FCA is concerned that consumers are not fully aware of the underlying investment risks due to the way some IFISAs are being marketed.
In a note on its website, the regulator states that it has ‘seen evidence that IFISAs are being promoted alongside cash ISAs’ which could be seen as implying that they share the risk profile of cash.
The note goes on to say ‘Investments held in IFISAs are high-risk with the money ultimately being invested in products like mini bonds or peer to peer investments,’
‘These types of investments may not be protected by the Financial Services Compensation Scheme so customers may lose the money invested or find it hard to get back.’
In a time of low returns from more conventional investments, it is natural for investors to be attracted by investments offering potentially higher returns but it is essential that they recognise that higher potential returns invariably come at the cost of higher risks and that they are comfortable with this. In the case of IFISAs, this higher risk comes from the facts that:
There is generally no FSCS protection and,
There is no guarantee the individual and business borrowers will be able to service the interest or, ultimately, repay the capital
The FCA’s warning about IFISAs followed closely upon the heels of its announcement that it intends to conduct an independent investigation into the collapse of London Capital & Finance.
High return investments are available even in the current market but investors should recognise that they expose them to more risk and that they should seek to mitigate those risks by careful consideration of the underlying investments themselves.