Calmar Ratio

The Calmar ratio is a juxtaposing of the average annual compounded rate of return and the maximum drawdown risk of commodity trading advisors and hedge funds. If the Calmar ratio is lower, the investment performed on a risk-adjusted basis over the specified period time is worse. On the other hand, the higher the Calmar ratio, the better it performed. Carlos Oliveira in his literary work entitled "Practical C++ Financial Programming" describing Calmar ratio as a "measure of investment returns as compared to possible annual losses. It is used to compare investments with different risk profiles. The Calmar ratio is defined as the average annual rate of return for a given period, divided by the maximum drawdown (i.e., the maximum loss) during the same period. If you consider the same rate of return, investment with higher Calmar ratio had lower risk during the considered period" (C. Oliveira 2015, p. 123).

$CalmarRatio={\frac {AnnualReturn}{MaximumDrawdown}}$

Annual Return

The annual return is the return that an investment submits over some time a while. It is defined as a time-weighted annual percentage. Sources of returns may include dividends, capital appreciation and returns of capital. The rate of annual return is pointed against the initial amount of the investment and represents a geometric mean rather than a simple arithmetic mean (B. R Hopkins 2012, p. 110).

Return Over Maximum Drawdown

The Return over maximum drawdown, in the field of hedge fund management, id described as the difference between a portfolio's maximum point of return, and any further low point of performance. The Maximum drawdown is the biggest difference between a high-water and a subsequent low. Maximum drawdown is the most popular way of expressing the risk of a given portfolio - particularly as associated track records become longer - for investors who believe that observed loss patterns over longer periods are the best available proxy for actual issuance. In general terms, return over maximum drawdown is simply the average return in a given year that a portfolio generates, expressed as a percentage of this drawdown figure (CFA Institute 2017, p. 190).

Difference Between Calmar Ratio and other ratios

The Calmar ratio is very similar to the Sharpe and Sterling Ratios, however, the main difference among these performance criteria is the proxy used for risk. The Calmar ratio is not as popular as the other to but is being used more frequently because it is simpler and easier to calculate than the Sterling or Sharpe ratios. What is more, the Calmar ratio gives a more realistic view of performance results. Reversely, the Sharpe ratio has the shortcoming of not reflecting the performance rightly in case autocorrelation is present in the returns. Greg N. Gregoriou is writing: "The Calmar ratio has numerous pitfalls the most prominent of which is ignoring the second and third greatest drawdowns. The other shortcoming is that the maximum drawdown is larger as the period time becomes longer; this characteristic of the Calmar ratio causes a lack of time-invariance" (G. N. Gregoriou 2008, p. 61).

Examples of Calmar Ratio

• For example, a fund with an average annual return of 10% and a maximum drawdown of 20% would have a Calmar ratio of 0.5 (0.10/0.20). This would indicate that the fund had higher risk compared to other investments with a similar return.
• Another example would be an exchange-traded fund (ETF) with a return of 15% and a maximum drawdown of 8%. In this case, the Calmar ratio would be 1.875 (0.15/0.08). This would indicate that the ETF had lower risk compared to other investments with a similar return.
• A third example would be a hedge fund with a return of 5% and a maximum drawdown of 10%. In this case, the Calmar ratio would be 0.5 (0.05/0.10). This would indicate that the hedge fund had higher risk compared to other investments with a similar return.

Advantages of Calmar Ratio

The Calmar ratio is a measure of investment returns as compared to possible annual losses, used to compare investments with different risk profiles. It is an important metric for investors to assess risk-adjusted returns and compare investments. The main advantages of the Calmar Ratio are:

• First, the Calmar Ratio can be used as a reliable metric to compare investments with different risk profiles. This allows investors to make informed decisions when selecting investments and assess their risk-adjusted returns.
• Second, the Calmar Ratio is easy to calculate, meaning investors can quickly and accurately measure the performance of a given investment.
• Third, the Calmar Ratio compares investment returns with maximum drawdown, meaning it captures both the positive and negative aspects of the performance of an investment.
• Finally, the Calmar Ratio is a useful metric for evaluating the performance of a fund over a specific period of time, as opposed to the performance of a single investment.

Limitations of Calmar Ratio

The Calmar Ratio has some limitations:

• Firstly, it does not take into account the investor's risk tolerance, which is a key factor in determining the overall risk of a particular investment.
• Secondly, it is based on historical data and does not account for potential changes in the future.
• Thirdly, it does not measure the potential upside of an investment and only looks at the downside risk.
• Finally, the Calmar Ratio is not a comprehensive measure of risk-adjusted performance and should not be used as the sole criterion for assessing an investment's performance.

Other approaches related to Calmar Ratio

Introducing other approaches related to Calmar Ratio, there is:

• Sortino Ratio - The Sortino Ratio is a risk-adjusted performance measure that is similar to the Sharpe Ratio, but adjusts for downside risk instead of total risk. It measures the return of an investment portfolio net of its downside risk. The higher the Sortino Ratio, the better the risk-adjusted performance of the investment portfolio.
• Omega Ratio - The Omega Ratio is a risk-adjusted performance measure that is based on the probability of achieving a given return. It measures the probability of achieving returns above a certain threshold over a given period of time. The higher the Omega Ratio, the better the risk-adjusted performance of the investment portfolio.
• Sterling Ratio - The Sterling Ratio is a risk-adjusted measure of the average return of an investment over a specified period of time, adjusted for its risk. It measures the return of an investment portfolio based on its volatility and the size of the drawdown. The higher the Sterling Ratio, the better the risk-adjusted performance of the investment portfolio.

In summary, the Calmar Ratio is one of several tools used to measure the risk-adjusted performance of an investment portfolio. Other risk-adjusted performance measures include the Sortino Ratio, the Omega Ratio, and the Sterling Ratio, each of which measures the return of an investment portfolio based on different criteria.

Calmar Ratio — recommended articles

Profit factor — Economic value of equity — Gordon Growth Model — Downside deviation — Blended Rate — Market Risk Premium — Free cash flow yield — Running yield — Vomma

References

• CFA Institute (2017), CFA Program Curriculum 2018 Level III, John Wiley & Sons
• Eling M. (2008), Does the Measure Matterin the Mutual Fund Industry?, "Financial Analysts Journal", Vol. 64, No. 3
• Gregoriou G. N. (2008), Encyclopedia of Alternative Investments, CRC Press
• Hopkins B. R. (2012), Starting and Managing a Nonprofit Organization: A Legal Guide, John Wiley & Sons
• Johnsson R. (2010), A Simple Risk-Return-Ratio, "Richard CB Johnsson, Ph.D. in Economics"
• Magdon-Ismail M. (2004), An Analysis of the Maximum DrawdownRisk Measure
• Oliveira C. (2015), Practical C++ Financial Programming, Apress
• Steinki O., Mohammad Z. (2015), Common Metrics for PerformanceEvaluation: Overview of Popular Performance Measurement Ratios, "Educational Series"

Author: Patryk Kozioł