What Is the Calmar Ratio, Its Strenths & Weaknesses?

What Is the Calmar Ratio?

The Calmar ratio is a gauge of the performance of investment funds such as hedge funds and commodity trading advisors (CTAs). It is a function of the fund's average compounded annual rate of return versus its maximum drawdown. The higher the Calmar ratio, the better it performed on a risk-adjusted basis during the given time frame, which is mostly commonly set at 36 months.

Key Takeaways

  • The Calmar ratio is a measure of risk-adjusted returns for investment funds, created by fund manager Terry Young in 1991.
  • The Calmar ratio uses a fund’s maximum drawdown as its sole measure of risk, which makes it unique. This could also be considered one of its weaknesses.

Calmar Ratio History

The Calmar ratio was developed and introduced in 1991 by Terry W. Young, a California-based fund manager. He argued that the ratio offered a more up-to-date reading of a fund's performance than the Sterling or Sharpe ratios, other commonly used gauges, because it was calculated monthly while they were done annually. The monthly update also made the Calmar ratio smoother than what Young called the "almost too sensitive" Sterling ratio.

The Calmar ratio is, in fact, a modified version of the Sterling ratio. Its name is an acronym for California Managed Account Reports. Young also referred to the Calmar ratio as the Drawdown ratio.

The Calmar Ratio's Strengths and Weaknesses

One strength of the Calmar ratio is its use of the maximum drawdown as a measure of risk. For one thing, it's more understandable than other, more abstract risk gauges, and this makes it preferable for some investors. In addition, even though it is updated monthly, the Calmar ratio's standard three-year time frame makes it more reliable than other gauges with shorter time frames that might be more affected by natural market volatility.

On the flip side, the Calmar ratio's focus on drawdown means it's view of risk is rather limited compared to other gauges, and it ignores general volatility. This makes it less statistically significant and useful.

Still, the risk-adjusted nature of the Calmar ratio makes it among many possible investment performance measures, though it is one of the lesser-known gauges of risk-adjusted returns. In fact, William Sharpe, creator of the Sharpe, won the Nobel Prize in economics in 1990 for his work on capital asset pricing theory.

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