Calming Ratio – What is it, definition and concept | 2022

The Calmar ratio is a parameter of investment performance that is defined as the ratio between the annualized return and the maximum drawdown of the asset.

Therefore, this is a suitable indicator to make investment decisions, especially in relation to Commodity Trading Advisors (CTAs) and hedge funds. Keep in mind that the return and drawdown used are those of the last 36 months.

While it is true that this ratio is the most widely used, there are other similar ones. Thus, we have the MAR ratio that uses longer periods, but with a very similar calculation. Others could be those that instead of the drawdown take volatility as a measure of risk, such as Sortino.

Calmar Ratio History

Its creator was Terry W. Young and the name is based on an acronym of the reports that he sent to his clients. Thus, these were called the California Managed Accounts Report and hence the Calmar ratio name.

Young was the owner of an investment company called California Managed Accounts, which managed funds for various clients. Thanks to this ratio, he could show them a comparison based on returns and risks that helped in decisions.

The drawdown and Calmar ratio

The drawdown can be defined as the difference between the reference maximum of a curve and the minimum, in a period of time. It is a measure of risk that is used in the Calmar ratio, instead of volatility.

In this way, the risk is measured as what we should earn to compensate for that drawdown. Thus, taking into account that the Calmar ratio formula that you can see below is the quotient of the return and the drawdown (in absolute value), the relationship between the two is clear.

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Calm Ratio 1

Characteristics of the Calmar ratio

Let’s see some of its related characteristics, in turn, with its advantages and disadvantages.

  • First of all, it is an indicator that is very easy to interpret. The higher the value, the better the position of said asset in its return-risk ratio.
  • On the other hand, it offers a practical guide to the investor to decide on his portfolio.
  • In addition, it can be used as a traffic light for risk, since we can establish maximum values ​​(good investments) and minimum values ​​(those that require attention).
  • One drawback is that it uses the drawdown and not the volatility, the latter being represented by the standard deviation, which is a more adequate indicator of risk.
  • It is a mathematical expression that does not take into account qualitative variables that affect the behavior of the sector.
  • It focuses on past developments and not on future projections.
  • It does not consider the effect of the country’s economic policy.

Calm ratio example

Finally, let’s see a fictitious example with data on certain hypothetical investments. We have the data of ten of them, both the annualized return and its drawdown.

Calming Ratio 1

In the last column we have created a hierarchy with the value of Calmar’s ratio, by means of a simple formula [jerarquía(número; referencia; orden)]. We see that, in this example, the investment with the best risk-return ratio is I2 and the least interesting is I4.

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