Why Smart People Do Daft Things

"I got it wrong, man. I got it totally wrong. It's a monumental f--- up. A total mess. The biggest f--- up of my life as a coach."

Pep Guardiola, post Bayern Munich 0-4 Real Madrid in the 2014 Champions League semi-final.

In the spring of 2014, Pep Guardiola’s stock couldn’t have been higher. He had already won the Champions League twice as Barcelona manager, building a side that would go down as an all-timer and playing a brand of football that would come to revolutionise the game for the next decade.

When he chose to leave Barcelona, his next move was to join fellow European heavyweights Bayern Munich as manager in 2013. By April the following year Bayern were winning the Bundesliga at a canter, and were into the semi finals of the Champions League - drawn against Barcelona’s fierce rivals, Real Madrid.

The first leg at the Bernabeu was tight, a 1-0 defeat for Bayern in a game they had dominated using the same shape and possession based game which come to represent their calling card under Guardiola. They keep the ball, win it back quickly and tire out the opposition by starving them of possession.

But before the return leg, for some reason Guardiola changed how he wanted to play. He instructed his players to use a formation they had not played before that season - an incredibly aggressive 4-2-4 system.

This would prove to be suicidal. With Bayern playing a recklessly high defensive line, any time Real won the ball they were free to counter attack with wide open space ahead of them. And this was the Real team of Ronaldo, Bale and Di Maria - pace to burn.

It ended 4-0, and 4-0 flattered Bayern. It could have been ten by half time. It was Bayern’s heaviest defeat in Europe, and the low point of Guardiola’s management career up to that stage. Why had he changed his mind? Why had he abandoned what had been working so well to date?

We are all human, and everyone makes mistakes. All we can do is try not to make them a habit.

Unfortunately for Pep, this would not be the only time he seemed to make a mess of his team’s chances by overcomplicating things. At times it didn’t seem enough to win the game, Guardiola seemed compelled to look like the smartest bloke in the room while he did it.

Bayern stumbled at the same hurdle in the 2015 Champions League semi final against Guardiola’s old side, Barcelona, after Pep changed his defensive set up for the away leg. Pep’s Manchester City team also lost Champions League knockout games against Lyon and Tottenham in similar fashion after Guardiola changed his tactics.

When he decided to play the European Cup final in 2021 without a defensive midfielder, City missed out on winning the big cup as they fell to defeat by an average Chelsea side.

The net result of all this, is that sat here today, Pep Guardiola has won the European Cup three times as a manager. Which for a mere mortal would obviously be amazing, but given his talent and the resources he has had at his disposal over the past eighteen years, feels a bit like underachievement.¹

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In my opinion one of the beautiful things about football, is that a point is a point is a point. No goal counts for more than any other.

And so there can be no “right way” to play the game. Want to suffocate your opponent playing beautiful Guardiola-esque possession based football? Fine. Want to punt it up to the big man, and hope for set pieces? Great! Whatever gives you the best chance of success.

But for goodness sake when you find an approach that works, stick to it and don’t change. To do so in a bid to look clever, looks a lot like arrogance.

The parallels with investing are obvious. As investors we do not get bonus points for style, outcomes are what matter.

And if we now have enough data to know what “works” - then why on earth would we deviate, other than possibly to sate our egos? It makes no sense.

Long Term Capital Management (LTCM) was a hedge fund set up in 1994 by John Meriweather, former vice-chairman and head of bond trading at Salomon Brothers. Myron Scholes and Robert Merton, two winners of the Nobel prize for Economics sat on the board. This was a financial institution run by the academic heavyweights of their time.

LTCM’s approach was to arbitrage small mis-pricings in a wide range of global securities. This strategy allowed LTCM to consistently generate positive returns for its investors.

But the returns on offer from these mis-pricings were fairly unexciting. So in a bid to “juice” the fund’s returns, LTCM borrowed money to leverage their trades - since LTCM’s model had worked well to date, adding debt to the fund’s exposure was not considered to be excessively risky.

But in 1998 LTCM blew up. When the Russian government defaulted on its debt, there was a rush from investors to sell all but the most boring securities in the world, and liquidity in the securities that LTCM held dried up - there were no buyers.

LTCM’s model relied upon “normal” trading conditions, which were in place 99.9% of the time. Unfortunately, in ‘98 the 0.1% chance came up and the model fell apart - LTCM had to unwind their trades at a loss to settle the debt they had accepted from the banks, and to pay back investor redemptions which were spiralling at an alarming rate.

The situation got so bad that the fund had to be “bailed out” by the same banks it did business with. Because LTCM had become so large, there was a very real concern that collapse for the fund could result in significant knock on effects (contagion) for the wider economy.

At one point, partners in LTCM had $1.9 billion in the fund. In the end, they ended up with nothing.

These were not stupid people. Quite the opposite, these were some of the brightest and best investors in the world. But once they had found the golden goose, they weren’t content with the eggs - they wanted more, needed more and it wiped them out.

Last week I wrote “some people are just too smart to be good investors”, and it’s a good line because it is true.

The most dangerous thing any of us can have in this game is an ego because if you get out over your skis, all the smarts in the world won’t save you.

Have a great weekend.

Past performance is not indicative of future returns. None of the above is intended to represent advice to any individual, if you have questions about your specific situation please consult with a regulated financial adviser.

1. Alex Ferguson also underachieved in Europe with the teams he had. Don’t @ me, it’s a fact.