Liquidity Crisis at Woodford Equity Fund Is Symptomatic of Systemic Problem, Bank of England Warns

$30 trillion of assets globally are held by similar open-ended funds.

The Bank of England warned on Thursday that “financial stability risks are increasing” from giant open-ended funds, which are estimated to hold some $30 trillion in assets globally. These funds are vast sources of financing for the real economy but can pose a systemic risk since the money often goes into assets that are hard to sell quickly, the central bank said in its latest Financial Stability Report.

If investors in an open-ended fund decide to pull their money en masse, which they’re ostensibly allowed to do at just about any time, the fund could struggle to liquidate its assets in time, especially if those assets are not very liquid.

This is exactly what has happened at the £3.7 billion Woodford Equity Income Fund, where a slow-motion (but accelerating) run on the fund prompted its manager, hedge-fund legend Neil Woodford, to place a ban on redemptions to avoid the risk of a fire-sale of its assets, below market value, against the interest of remaining investors. Since then, hundreds of thousands of investors, including public pension funds, have been unable to access their money.

The Bank of England’s Financial Policy Committee (FPC) already warned in 2015 about “the vulnerabilities associated with liquidity mismatch in funds that offered short-term redemptions while investing in longer-dated and potentially illiquid assets.” But no action was taken.

Now, the FPC says the Bank of England and the Financial Conduct Authority (FCA) will review how funds are able to offer daily redemptions while pouring money into assets that can take weeks or months to sell in an orderly fashion. “This can create an incentive for investors to redeem when they expect others to do so,” the FPC said, adding that this mismatch in liquidity “has the potential to become a systemic issue”.

In the case of Woodford, he was able to circumvent a 10% limit on illiquid assets by bundling up his fund’s unlisted assets and listing them on the minuscule Guernsey-headquartered International Stock Exchange, which has barely any trading activity at all and cannot provide liquidity to illiquid assets.

But it didn’t take long for investors to smell a rat. The total amount under management at Woodford has steadily shrunk by almost two thirds since 2015, from £10.2 billion to £3.7 billion. In early June, a request by Kent County Council to withdraw £250 million — the equivalent of around 4% of the total investments of its £6.4 billion pension fund — was the final straw. Instead of releasing the funds, Neil Woodford slammed the doors shut…

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