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KPI of the Day – Investment: # Calmar ratio

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calmar ratio

Definition

Measures the relationship between return relative to drawdown (downside) risk in a hedge fund.

Purpose

To evaluate the return vs. drawdown risk.

Recommendations

The term Calmar ratio was introduced by Young (1991). Calmar is an acronym for California Managed Accounts Reports, which is the name of Terry Young’s company. Similar measures, including the Pain ratio and the Ulcer Index, further incorporate the duration and depth of drawdowns since the previous high-water mark. The range of combined risk and return measures available for hedge fund investors is almost limitless.

In the finance industry, financiers are expected to balance risk and returns on investments. Effective financial strategies target an increase in returns, but also risk-adjusted returns. However, identifying risk is one of the major challenges faced by professionals in the finance industry.

There are several methods that enable risk identification processes, and they imply the use of performance measurement tools such as the Sharpe Ratio, the MAR Ratio, and the Calmar ratio. By making use of the # Calmar ratio, in particular, financiers can look into the statistical performance of an investment, and present it accordingly to the investors.

One of the strengths of the # Calmar ratio is that it showcases the actual drawdown on hedge fund investments instead of their volatility. Drawdown is arguably a better measure of risk than volatility, as solely measuring volatility sometimes distorts the real value of the drawdown risk.

When accurately employed, the # Calmar ratio can give a definite trend on the performance of hedge fund investments, since it presents a month-to-month statement that makes it easier for financiers to gain insight into the evolution of significant assets.

Other recommendations to optimize the # Calmar ratio are as follows:

  • Ensure regular data collection to increase accuracy in reporting;
  • Automatize and digitize data collection to reduce human errors;
  • Complement short-term risk analysis with long-term risk analysis which make use of additional indicators such as the # MAR ratio.

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