What Is Return Over Maximum Drawdown (RoMaD)?

Return over maximum drawdown (RoMaD) is a risk-adjusted return metric used as an alternative to the Sharpe Ratio or Sortino Ratio. Return over maximum drawdown is used mainly when analyzing hedge funds. It can be expressed as:

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Introduction To Hedge Funds

Return over maximum drawdown is a nuanced way of looking at a hedge-fund performance or portfolio performance in general. Drawdown is the difference between a portfolio's point of maximum return (the "high-water" mark) and any subsequent low point of performance. Maximum drawdown, also called Max DD or MDD, is the largest difference between a high point and a low point.

Maximum drawdown is becoming the preferred way of expressing the risk of a hedge-fund portfolio for investors who believe that observed loss patterns over longer periods of time are the best proxy for actual exposure. This is because these same investors believe hedge-fund performance does not follow a normal distribution of returns.

Return over maximum drawdown is the average return in a given period for a portfolio, expressed as a proportion of the maximum drawdown level. It enables investors to ask the question, "Am I willing to accept an occasional drawdown of X% in order to generate an average return of Y%?"

For example, if the maximum achieved value for a portfolio to date was $1,000 and the subsequent minimum level was$800, the maximum drawdown is 20% [($1000 –$800) ÷ \$1000]. That is a scary number for investors, particularly if they were to bail out at the bottom with their investment 20% lighter.

Of course, that is only half the story. Imagine the same portfolio had an annual return of 10%. In that case, you have an investment with a maximum drawdown of 20% and a return of 10% for a RoMAD of 0.5. Now an investor can use that benchmark to compare performance with other portfolios. A RoMaD of 0.5 would be considered the more attractive investment over one with a maximum drawdown of 40% and a return of 10% (RoMaD = 0.25).

On the surface, the returns of these two portfolios are the same, but one is much riskier.