'I have started to become more concerned about one particular risk: that of "fine inflation" in the banking industry,' Woodford said in his latest update.
'Clearly, banks have attracted many fines in the post-financial crisis world as regulators and policy-makers have cracked down on past and ongoing wrongdoings in the industry. The size of the fines, however, appears to be increasing.'
Woodford highlighted the $1.9 billion penalty HSBC incurred for failing to prevent Mexican drug cartels laundering money through its bank accounts.
The recent $16.7 billion fine Bank of America paid to end investigations into its role in the run up to the financial crisis, selling toxic mortgages, has also spooked Woodford.
Woodford is worried that the size of fines among banks have become impossible to quantify.
'I am concerned, however, that these fines are increasingly being sized on a bank’s ability to pay, rather than on the extent of the transgression,' he said.
'In particular, I am worried that the ongoing investigation into the historic manipulation of Libor and foreign exchange markets could expose HSBC to significant financial penalties. Not only are these potentially serious offences in the eyes of the regulator, but HSBC is very able to pay a substantial fine.'
He added: 'The size of any potential fine is unquantifiable, so this represents an unquantifiable risk. Nevertheless, a substantial fine could hamper HSBC’s ability to grow its dividend, in my view.
'I have therefore sold the fund’s position in HSBC, reinvesting the proceeds into parts of the portfolio in which I have greater conviction.
'Sometimes, the evolution of an investment case can be subtle but significant enough to represent a change.'
Until last year, Woodford had not owned a bank since 2002, owing to a range of concerns. These included worries about the quality of loan books, capital adequacy and high leverage ratios. He felt the process of post-crisis balance sheet repair still had a long way to go, particularly for the UK-focused high street banks.
However, he was happy to accommodate HSBC, describing it as a 'different beast'.
'It is a conservatively-managed, well-capitalised business with a good spread of international assets. As chief executive, Stuart Gulliver has done a great job over the last four years, making a very complicated organisation much simpler to understand.'
He added: 'It is still a huge and complex business, however – its 2013 annual report & accounts document runs to around 600 pages, many of which are dedicated to the risks that it faces.
'It is a challenged business in a troubled sector, but it has navigated through the headwinds that have blighted the banking industry in recent years robustly.'
While Woodford admitted he questioned its valuation at times both pre and post financial crisis, he pointed out that over the past couple of years it has returned to a more attractive valuation level, regularly trading at around or even below its book value made it an appealing investment.
This prompted his to build a position in the bank last May and it was included it in the portfolio of the CF Woodford Equity Income fund.
Woodford has reinvested the proceeds into areas where he has greater conviction and on better valuations.
Ideas in this sphere included AstraZeneca, BAE Systems, Drax, Legal & General.
'I believe the long-term interests of my investors will be better served by focusing the portfolio towards them,' Woodford said.