The fifth anniversary of the closure of the Woodford Equity Income Fund (WEIF) is two weeks away. More than 300,000 investors were affected by WEIF’s implosion. Some of them planned to retire by now but are still having to work to recoup the money they lost. Many died without receiving any compensation.
You would hope by now the financial industry would have learned the lessons of this sorry saga. Alas I fear it hasn’t, and, five years on, the chance of a recurrence has never been greater.
WEIF blew up because of liquidity issues that were allowed to fester. With redemption requests mounting, Neil Woodford was forced to dispose of liquid shares, which left the portfolio filled with hard-to-sell illiquid investments. Eventually, the only way for Link, the fund’s administrator, or ACD, to avert a catastrophic fire sale was to suspend and eventually close it.
Last month, in a tearful interview, Woodford insisted he could have turned things round if given more time. It has since become clear how fanciful a claim that is. At the height of the crisis, another Woodford-managed fund, the Patient Capital Investment Trust, bought some of WEIF’s highest-risk, illiquid investments. Schroders, which now manages that fund, recently announced that it continues to write down those legacy assets. Investors who bought in at the start have now lost 89.5% of their money.
We never had an inquiry
So why do I think the risk of anther Woodford-style blow-up is now so high? The first reason has been well documented: we’ve never had a proper inquiry into what went wrong. Yes, Link has been fined, but other major players, like Woodford’s cheerleader-in-chief, Hargreaves Lansdown, appear to have escaped scot-free. Woodford himself, who earned huge fees from WEIF and, with his business partners, withdrew £98 million in dividends from Woodford Investment Management before its collapse, has not been punished either.
This all sends out a dangerous signal to the industry: the regulator is not as bothered as it should be with protecting the consumer, and, as long as you stay within the letter of the rules, you can more or less do what you want and still avoid censure.
There is, however, a second and more pressing reason why the risk of a sequel to the Woodford scandal is now so great: funds are stocking up on illiquid assets such as private equity and venture capital like never before.
Why is this happening? It’s partly active money managers are under huge commercial pressure. Investors are moving their money out of actively managed funds and into much cheaper index trackers faster than ever. The $450 billon investors removed from active funds in 2024 was another record. The only way that active managers can generate the fees they used to enjoy is by focussing on more lucrative areas like alternative investments.
Ministers are fanning the flames
Worryingly, though, there is also pressure on funds from politicians, including government ministers, in the UK, the US and elsewhere, to invest in small, unlisted companies. What’s more, these same politicians are also encouraging pension funds and even ordinary investors to use funds that invest in illiquid securities.
It concerns me too that some financial advisers are starting to promote illiquid investments they may not fully understand.
“This coming year,” Jason Zweig wrote recently in the Wall Street Journal, “your financial adviser may inundate you with pitches to buy private assets. You should evaluate them with more scepticism than ever."
Why? Because, Zweig explained, private equity usually comes with higher fees, greater risk, more conflicts of interest and a hard sell. Another big problem, he suggested, is that many illiquid assets simply look like bad investments.
”Managers of alternative funds have struggled to resell a glut of overpriced assets," he wrote. "No wonder there’s an intensifying push to strip away the traditional protections for smaller investors.”
The FCA must provide clarity
So how can we avoid a repeat of Woodford? First, we all need to be much more mindful of the dangers. “Just like banks,” Patrick Hosking recently wrote in The Times, “open-ended funds are hugely vulnerable to sudden outflows. They are required to meet redemption requests immediately, yet are allowed to hold assets that are not immediately convertible into cash. That fundamental mismatch is unsolvable.”
The crucial issue the FCA needs to address is this: Whose job is it to ensure a fund's liquidity? Is it the ACD? Is it the fund manager? My own view is that it should be both. Either way, we need to have absolute clarity on who is responsible. The FCA should also make it clear that funds and administrators that put investors’ savings in jeopardy by allowing illiquidity to get out of hand will be swiftly and harshly dealt with.
As Hosking rightly says, Woodford’s tearful interview left big questions unanswered. The FCA risks another financial scandal, perhaps even bigger than Woodford, if it doesn’t find answers soon.
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