Why would HSBC Holdings PLC, the biggest bank in Europe, allegedly get involved in the relatively penny-ante and shameful act of helping wealthy clients sidestep the taxman?
One explanation is arrogance. A more convincing rationale, though, is that it didn't have a clue about what else it could do.
Financial institutions everywhere are faced with a similar challenge: They want to build their wealth management arms. However, the most lucrative and effective way to do that – by attracting ultra-rich clients – runs into the vexing issue that it's hard to beat a simple portfolio of low cost index funds.
Even the world's most powerful banks can't offer bespoke investment advice to multimillionaires that is reliably superior to what a guy on the assembly line can purchase through a discount broker.
For financial institutions, this poses a problem. Their standard response is to attempt to lure the wealthy with ancillary services such as estate and tax planning, but banks hungry for affluent clients will be sorely tempted to cross the line from aggressive tax planning to outright tax evasion.
For Swiss banks especially, the temptation has proven hard to resist. UBS paid a $780-million (U.S.) fine in 2009 for helping thousands of clients evade taxes, while Credit Suisse shelled out $2.6-billion last year for conspiring to help Americans hide income from the tax man.
HSBC is headquartered in Britain, but its alleged offences took place at its Swiss private bank between 2005 and 2007. After some details came to light, HSBC took out full page ads in several newspapers this month to apologize to customers. It declared the private bank has changed the way it does business and that it has no desire to do business with tax evaders.
This is no doubt true, but it would require an unusually trusting person to conclude that we won't see similar offences at other banks in the future. The pressure to attract rich clients is enormous, yet there's no way to tempt them with the most natural sale pitch – reliably superior performance. Markets are too efficient and competition too fierce to allow any institution to consistently beat the market.
This has been particularly evident in the recent stages of the current bull market. In Canada, only about 20 per cent of active money managers are beating the S&P/TSX Composite, according to the most recent figures compiled for Standard & Poor's SPIVA scorecard. Similarly, only 19 per cent of U.S. equity fund managers surpassed the Russell 1000 index of large stocks last year, according to Bank of America Merrill Lynch.
Over five years, the vast majority of active managers in every category fail to consistently outperform, according to S&P data.
The picture stays the same even if you drop mass-market mutual funds and focus only on hedge funds, an investment category typically targeted at wealthy, experienced investors.
Research by Ilia Dichev of Emory University and Gwen Yu of Harvard University found hedge fund investors, on average, fared only slightly better between 1980 and 2008 than if they had stashed their money in government bonds.
Despite the reverence with which hedge fund managers are treated, their investors seem to do only marginally better than the folks who buy GICs.
Even the world's greatest investor has come around to endorsing humble index funds. Back in 2008, Warren Buffett made a $1-million wager with Protege Partners, an alternative asset manager. The Oracle of Omaha bet that an S&P 500 index fund would outpace Protege's hand-picked roster of hedge funds over the course of 10 years. So far, he's way ahead.
If banks' wealth managers can't help their clients consistently beat a simple indexing strategy, the pressure will be unrelenting to find other ways to attract well-heeled clients.
HSBC's recent string of mishaps – including a money-laundering scandal and penalties for foreign exchange manipulation – demonstrate how intense that pressure can be. And it suggests that the recent spate of banking scandals won't be the industry's last.