Snapshots is trying to avoid the Aussie flu which is causing the worst flu season in the UK since the 2011 swine flu. The Centre for Disease Control recommends a six feet clearance from contaminated persons.

The Six Foot Tall Man

Speaking of six feet, one of our favourite quotes in 2017 was: “Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average.”* A good example of this was a pool of Buy To Let mortgages that we analysed recently.  It advertised an average (mean) Loan To Value (LTV) of 67%.  This looks conservative and within the Bank of England’s Adverse Credit Scenario stress test of a 33% fall in residential property prices.  Therefore on average, we would expect very low losses on the portfolio even when borrowers default.

However, when we looked into the portfolio, the most frequent cohort of borrowers (the mode) had an LTV of 75-80%.  This obviously changes the distribution of the losses that can occur when borrowers default and in turn, can create very different pricing dynamics to the ABS security that contains the portfolio.

As we have said a number of times, in maturing credit cycles, it is questioning and analysing the small details that increase survivorship probability if the market turns.

Record Breaking Default Run

Sticking to the theme of averages, according to S&P’s Annual Global Corporate Default Study, 2012-2016 is the longest streak of zero defaults in investment grade credit since its records began in 1987.  The 2017 numbers are not out until April.  Carillion, the large UK construction and services company, which went into liquidation this week was not rated by S&P and would not occur in the default study, but it was widely considered to be investment grade rated by banks and investors a year ago.  The troubled retailer Steinhoff was also investment grade rated last year and jumped straight to CCC.

The distress of these two issuers is not statistically significant but as we said last year, when default rates move back to their cycle averages (means), they do this via a clustering of defaults which usually occur at the end of business cycles.  To put this in a statistical context, the distribution of defaults through a business cycle follows a bi-modal distribution around the mean.  In a laypersons context, this means watch out!


We would like to thank Peter Tchir from Academy Securities again for pointing out the latest innovation in the ETF market which is a leveraged version of an ETF of ETFs.  This sounds like some of the crazy products the credit market created before the last crisis like CPDOs and CDOs squared.  The obvious difference here is that there is no complicated tranching of risk involved.  This is a good old fashioned asset-liability mismatch being amplified.

This is because bond ETFs buy long dated assets and finance them with short dated liabilities through a daily redemption mechanism.  Manufacturing ETFs of ETFs and leveraging these ETFs of ETFs magnifies that asset liability mismatch in the markets.

*Howard Marks – The Most Important Thing – Columbia University Press 2013

Good luck.


Asif Godall
Co-Chief Investment Officer