Liquidity Risk in Illiquid Assets: Lessons from the Woodford Equity Income Fund Collapse

The 2019 collapse of the Woodford Equity Income Fund (WEIF) stands as a cautionary tale for investors and regulators alike, exposing the perils of misaligned liquidity risk management in private equity and illiquid assets. The scandal, which left 300,000 retail investors with frozen capital and significant losses, underscores a critical flaw in fund governance: the failure to reconcile daily redemption terms with the inherently illiquid nature of the underlying portfolio.

Regulatory Failures and Governance Gaps

The Financial Conduct Authority (FCA) later concluded that the fund's authorised corporate director, Link Fund Solutions (LFS), and its manager, Woodford Investment Management (WIM), had catastrophically underestimated liquidity risk. The fund's portfolio, heavy with unquoted equities and private investments, lacked the liquidity to meet redemption demands during a market downturn. LFS was found to have failed in its duty to oversee WIM's risk framework, while Neil Woodford himself was accused of a “defective and unreasonably narrow understanding” of liquidity management.

The FCA's enforcement actions, including a £230 million redress scheme for investors, revealed systemic weaknesses in the UK's regulatory framework. Critics argued that the FCA had ignored early warnings about the fund's concentration in illiquid assets and its reliance on optimistic redemption assumptions. The regulator's delayed publication of enforcement notices against Woodford and WIM—until February 2025, a year after their issuance—further eroded trust in its transparency.

Post-Woodford Reforms and Industry Shifts

In response to the crisis, the FCA has introduced stricter liquidity risk oversight for open-ended funds, emphasizing stress testing and alignment between redemption policies and asset liquidity. These reforms, part of broader “Edinburgh Reforms” post-Brexit, aim to prevent a recurrence of the WEIF-style liquidity mismatch. For instance, the FCA now mandates that funds holding more than 10% in illiquid assets must justify their redemption terms rigorously.

The scandal also prompted a reevaluation of fund structures. Jupiter Fund Management, among others, announced it would cease investing in unlisted companies, a move reflecting the industry's growing recognition of liquidity risk. Meanwhile, the Bank of England's Mark Carney famously condemned the practice of offering daily redemptions on illiquid portfolios as “built on a lie,” advocating for closed-ended investment trusts as a more appropriate vehicle for such assets.

Investment Implications and Lessons Learned

For investors, the WEIF crisis highlights the importance of due diligence in funds with high exposure to illiquid assets. Key lessons include:
1. Demand Transparency: Investors must scrutinize a fund's liquidity profile, redemption policies, and stress-test scenarios.
2. Diversify Access: Illiquid assets should be held in closed-end structures (e.g., investment trusts) rather than open-ended funds, which face redemption pressure.
3. Monitor Governance: Independent oversight of fund managers is critical. The failure of LFS to challenge WIM's strategies exemplifies the risks of inadequate corporate governance.

The FCA's ongoing legal battles with Hargreaves Lansdown, which faces lawsuits from 5,000+ investors for promoting the WEIF despite its risks, further emphasize the need for platforms to vet funds rigorously. For asset managers, the WEIF case serves as a stark reminder that liquidity risk is not just a regulatory concern but a reputational and operational one.

Conclusion

The Woodford Equity Income Fund scandal remains a watershed moment in UK financial history, reshaping regulatory frameworks and investor expectations. While post-crisis reforms have strengthened liquidity risk management, the incident underscores the enduring challenge of balancing investor access with asset liquidity. For investors seeking exposure to private equity or illiquid assets, the lesson is clear: prioritize transparency, demand robust governance, and recognize that liquidity is not a given—it must be engineered.

As the FCA continues to refine its oversight, the industry must remain vigilant. The WEIF collapse was not an anomaly but a symptom of a broader misalignment between fund structures and the realities of illiquid markets. For those willing to navigate these complexities with care, the path forward lies in innovation, transparency, and a renewed commitment to investor protection.