What Is a Peak-To-Valley Drawdown?
A peak-to-valley drawdown is a fund's or money manager's largest cumulative percentage decline in portfolio value. It is defined as the percentage decline from the fund's highest value (peak) to the lowest value (trough) after the peak. Funds that have been in existence for long periods of time may have several peak-to-valley drawdowns over various time periods.
Understanding Peak-To-Valley Drawdown
Peak-to-valley drawdown can help an investor to gauge the risk of a portfolio. It is a performance and risk-reporting measure that some funds may use. It is often more commonly found reported with characteristics of higher risk portfolios, such as hedge funds and managed futures strategies.
Investors can also follow peak-to-valley drawdowns with long-term historical return data. Creating an individual peak-to-valley drawdown report may be necessary for this type of analysis since it is not often provided automatically by investment managers. When analyzing or creating your peak-to-valley analysis, there are several measures associated with peak-to-value drawdowns that can provide greater insight about a fund.
Drawdown Reporting and Calculations
A drawdown report can show the peak-to-valley losses of a portfolio for a single month or a cumulative time period consisting of several consecutive months. Some of the important factors in a peak-to-valley drawdown report’s calculations include the following:
Depth: This is a measure of the percentage loss from peak to valley.
Length: This shows investors the length of time associated with the loss. The length of time associated with peak-to-valley drawdowns can help an investor better understand the volatility of the portfolio.
Recovery: Recovery can be an important factor, followed closely by many investors. It shows the amount of time from the portfolio's valley to a new high.
Average recovery time: The average recovery time is useful for understanding a portfolio’s peak-to-valley drawdowns comprehensively. The average recovery time is a measure of recovery time-averaged from all of a portfolio’s peak-to-valley drawdowns historically since its inception.
Declines in a portfolio’s asset value are inevitable. However, the magnitude of peak-to-valley losses and their occurrences over time can be important considerations for investing in a fund. While losses will occur, investors prefer lower loss magnitudes and low average recovery times that do not rely on riskier bets for improving performance.
In some cases, annual fees may also be a contributor to peak-to-valley drawdowns. Fees are a regular expense that investors usually pay indirectly, which affects the fund’s value. If fees are paid during down-trending performance, this can increase the losses an investor sees in asset value.