Calmar Ratio

When evaluating an investment or a trading system, it is important to consider not only the potential returns but also the extent of declines it experiences from peak values over time. The Calmar ratio may help investors do that. It links the annual return to the worst loss from a peak to a trough. This is useful because deep losses may force investors to exit early, miss the recovery, or breach risk limits. By focusing on the largest historical drop, the Calmar ratio draws attention to potentially unfavourable outcomes that may affect investor behaviour.

Table of contents

• What is the Calmar ratio?
• The formula of the Calmar ratio
• Examples of the Calmar ratio
• Components of the Calmar Ratio
• Advantages of the Calmar ratio
• Calmar ratio vs. other measures of risk-adjusted performance
• History of the Calmar ratio
• Disadvantages of the Calmar ratio
• Interpreting changes in the Calmar ratio

What is the Calmar ratio?

The Calmar ratio shows how much annual return is earned for every unit of the worst historical decline. It is calculated over a set period (often three years) and is used to compare funds or strategies that have similar returns but different risk profiles. A higher Calmar ratio indicates the strategy produced more return for the level of severe stress it experienced. In summary, it measures potential return efficiency against real, lived drawdowns rather than everyday price noise.

The formula of the Calmar ratio

Calmar ratio = Average annual return ÷ Maximum drawdown (over the same period)

Average annual return is usually the compound annual growth rate (CAGR) when it is evaluated over more than one year. Maximum drawdown is the largest percentage fall from any portfolio peak to the next trough within the chosen window.

Examples of the Calmar ratio

Let’s examine the Calmar ratio through three scenarios.

Example 1: A fund on average grows 18% per year over three years (CAGR), registering its worst drawdown of 12% during this period.

Calmar ratio = 18% ÷ 12% = 1.50.

Example 2: You start with Rs. 10,00,000 and end the year at Rs. 12,00,000 (≈20% gain). During the year, your investment value falls from Rs. 11,00,000 to Rs. 9,35,000 (−15%).

Calmar ≈ 20% ÷ 15% = 1.33.

Example 3: Two strategies both deliver 22% per year. Strategy A’s worst drawdown is 30% (Calmar ≈ 0.73). Strategy B’s worst drawdown is 14% (Calmar ≈ 1.57). Even with equal returns, Strategy B had a higher Calmar ratio, translating into a less volatile investment experience in the period under consideration.

Example for illustrative purposes only; Past performance may or may not be sustained in future.

Read Also: Price-to-Earnings (P/E) Ratio: Meaning, Uses and Formula

Components of the Calmar Ratio

• Returns: Use CAGR for multi-year periods so compounding is captured.
• Maximum drawdown: Reflects the biggest peak-to-trough hit.
• Lookback period: Three years is common; it can also track rolling 12- and 36-month values to see how conditions change.
• Data frequency: Daily data is used to identify peaks and troughs. Intraday data may show deeper temporary declines and lower the ratio.
• Consistency: Apply the same rules (costs included, same window, same pricing source) when comparing funds.

Advantages of the Calmar ratio

• Focus on real stress: It highlights strategies that collapse during shocks, even if the volatility may not be significant for the rest of the period.
• Easy to read: “Annual return per unit of worst loss” is a simple explanation of the metric.
• Aids selection: It helps investors choose between systems with similar returns but very different drawdown behaviour.
• Portfolio design: It may help prevent one sleeve from dominating the overall portfolio drawdown.
• Discipline: It may encourage better position sizing, hedging, and diversification to limit the denominator (drawdown).

Calmar ratio vs. other measures of risk-adjusted performance

• Sharpe ratio: Sharpe divides excess return by standard deviation. It may appear favourable even if a strategy is exposed to a rare but heavy crash. Calmar focuses more on tail risk.
• Sortino ratio: Sortino uses downside deviation and is more forgiving than Sharpe, but it still focuses on regular variations. Calmar looks only at the worst episode.
• MAR ratio: MAR is similar (CAGR ÷ max drawdown) but often uses the full track record, which can reduce comparability across funds of different ages. Calmar typically uses a fixed recent window.
• Information/Omega: These add benchmarks or full distribution detail. They are helpful, but Calmar gives a direct view of capital impairment risk.

History of the Calmar ratio

The ratio is widely associated with Terry W. Young, who promoted it in the 1990s through the “CALMAR” newsletter (California Managed Accounts Reports). It gained traction in managed futures (CTA) and trend-following, where investors care deeply about avoiding long, deep underwater periods. From there, it moved into broader hedge-fund and even retail analysis.

Disadvantages of the Calmar ratio

• One event can dominate: A single shock can depress the ratio for a long time, even after a process change.
• Recovery speed not factored in: Two strategies with the same lowest drawdown but different recovery times get the same denominator.
• The choice of time window: A favourable or unfavourable period can distort readings; use rolling windows to reduce this.
• No benchmark context: It does not show whether everyone fell together (for example, in a market crash).
• Data quality risk: Inaccurate price marks, survivorship bias, or ignoring costs may mislead.

Read Also: Information Ratio - Meaning, Formula, and Calculation

Interpreting changes in the Calmar ratio

If the ratio rises, it indicates that either returns have increased, drawdowns have decreased, or both. That may reflect improved sizing, greater diversification, or hedges. If it falls, more return is being bought with too much stress—often a sign of higher leverage, crowding, or a regime shift. Track a rolling 12-month and 36-month Calmar. When it weakens, investors may consider auditing max-drawdown episodes for causes such as concentration, liquidity gaps, or event risk. Responses may include trimming exposure, adding diversifiers, capping single-name risk, or using options to limit tails.

Conclusion

The Calmar ratio focuses on the type of losses that tend to concern investors the most — significant drawdowns that can test their willingness to stay invested. It may be used to compare strategies with similar CAGRs but different risk experiences. When viewed alongside other measures such as Sharpe and Sortino ratios, it helps to obtain a more rounded assessment of risk-adjusted performance. It is important to review it on a rolling basis and tie it to clear risk actions. The aim is to pursue potential returns in a way that aligns with the investor’s risk tolerance and financial capacity.

Frequently Asked Questions

What is a good Calmar ratio?

The suitable Calamar ratio depends on fund strategy, asset class, and investment style, so there is no universally ‘good’ measure. However, for diversified, liquid strategies, a value above 1.0 over multi-year windows is generally acceptable. Values of 1.5–2.0 may be viewed as relatively favourable. Very high numbers may need to be checked for short samples or unusual market conditions.

How is the Calmar ratio calculated?

It is calculated by dividing the average annual return (often CAGR) by the maximum drawdown measured over the same period. Ensure both are net of costs and that drawdown is an absolute percentage, not a signed value.

What is the difference between the Sharpe ratio and the Calmar ratio?

Sharpe ratio measures return relative to day-to-day volatility. Calmar ratio measures return relative to the single worst peak-to-trough loss. The Sharpe ratio doesn’t fully reflect big market drops, but the Calmar ratio does.

What is the Calmar ratio for hedge funds?

There is no single standard across all strategies. Many allocators look for values above 1.0 and prefer 1.5 or higher over longer windows. The target depends on the strategy’s leverage, liquidity, and market regime.

Is a higher Calmar ratio better?

Generally, yes. A higher Calmar ratio indicates more return for each unit of worst historical loss. However, it is advisable to confirm that the sample is long enough and that the result is stable across rolling windows before relying on it.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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