The Calmar ratio: return measured against your worst loss

The lesson in plain words

The same lesson as the slides above, written out in full.

1. The Calmar Ratio

Welcome. The Calmar ratio cuts through the noise and asks the question that matters most to anyone putting real money at risk. How does your return compare to the worst loss you suffered getting there? It is a wonderfully honest measure, because it weighs the reward against the deepest pain, the kind of pain that actually makes people abandon a strategy. One note before we begin. This is financial education only, not financial advice.

• Calmar asks the question that matters most: return against the worst loss suffered.
• It cuts through the noise to what real money actually feels.
• A strategy is only as good as the drawdown you can survive.

A quick note: This is financial education only, not financial advice. Do not buy, sell, or hold anything based on this lesson.

2. Return Over Worst Loss

The formula is simple. The Calmar ratio is your annualised return divided by your maximum drawdown, the worst peak to trough fall. So if you returned fifteen per cent a year, and your worst decline along the way was ten per cent, your Calmar ratio is one point five. You earned one and a half units of return for every unit of maximum pain. The higher the number, the better the deal you got for the risk you actually lived through.

• Calmar is annualised return divided by maximum drawdown.
• A 15% return with a worst drawdown of 10% gives a Calmar of 1.5.
• You earned 1.5 units of return for every unit of maximum pain.
• The higher the ratio, the better the deal for the risk endured.

3. Why It Beats Sharpe Sometimes

Here is why Calmar sometimes beats the more famous Sharpe ratio. Sharpe uses standard deviation, which measures all volatility, both up and down. But investors do not lose sleep over upside volatility. Nobody complains about an unexpectedly large gain. Calmar focuses only on what actually hurts, the worst drawdown. So consider two strategies. One delivers a steady twelve per cent with a maximum drawdown of eight, a Calmar of one point five. The other delivers twenty per cent but with a forty per cent drawdown, a Calmar of nought point five. The first is arguably the better strategy, even though the second made more money, because far more people could actually hold on through it.

• The Sharpe ratio uses all volatility, both up and down.
• But nobody loses sleep over large gains: only the downside hurts.
• Calmar focuses on the worst fall, the pain that actually matters.
• A steady 12% with an 8% drawdown can beat a wild 20% with a 40% drawdown.

4. What Good Looks Like

Reading the number. Below nought point five, the drawdowns are eating most of the return, and the strategy may be too painful to stick with even if it is ultimately profitable. Nought point five to one is moderate, the returns justify the pain but you should expect some uncomfortable periods, and most equity indices fall here over the long run. One to two is good, you are being well compensated for the worst case scenario, and many successful hedge fund strategies target this range. Above two is excellent. As always, read Calmar beside the raw return and the other measures, never in isolation.

• Below 0.5: drawdowns are eating most of the return; hard to stick with.
• 0.5 to 1.0: moderate; the returns justify the pain, with uncomfortable spells.
• 1.0 to 2.0: good; you are well compensated for the worst case.
• Above 2.0: excellent, and where many strong strategies aim.