What is Calmar Ratio?

Calmar ratio refer to ratio of average annual rate to return to risk related to hedge funds and investments as it shows the relationship between return and risk and it is calculated by average annual rate of return divided by maximum drawdown for previous three years which is used to evaluate the performance of different hedge funds and to take decisions relating to investment. It was invented by Mr.Terry W. young in 1991 in the United States and is the short form for the company of Terry Young named “ California Management Account Reports”.

Formula

Calmar Ratio is more used in selecting a mutual fund or a hedge fundA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques.read more to evaluate the performance of the two and make a decision on the investment.

Calmar Ratio = Average Annual Rate of Return / Maximum Drawdown.

Calmar-Ratio

You are free to use this image on your website, templates etc, Please provide us with an attribution linkArticle Link to be Hyperlinked
For eg:
Source: Calmar Ratio (wallstreetmojo.com)

*Here, both the numerator and denominator are calculated for the past three years.

Examples

You can download this Calmar Ratio Excel Template here – Calmar Ratio Excel Template

Example #1

Suppose A hedge fund has an annual rate of return for the past 3 yrs is 25%. The fund started its activity with $10,000, which rose to $25,000 and then drop to $8,000 due to crises.

Solution:

Here the maximum drawdown needs to be computed for the fund in the following way :

Maximum Drawdown = ($25,000-$8,000)/ $25,000 = 68%.

Based on the above information, we can calculate the Calmar Ratio as below :

Calmar

= 25%/68%

Calmor Ratio = 0.3676.

Example #2

Suppose there are two Funds, Fund A and Fund B. Below are the details of each fund. Which fund would be more beneficial for the investor to invest.

FundAvg Annual ReturnMax Drawdown
Fund A25%68%
Fund B20%40%

Solution :

The Calmar Ratio of Fund A can be calculated using the above formula as,

Example

= 25%/68%

Calmar Ratio of Fund A =0.37

The Calmar Ratio of Fund B can be calculated using the above formula as,

Example

=20% / 40%

Calmar Ratio of Fund B =0.5

In the above example, an investor would be tempted to go for fund A, since it gives a higher annualized rate of returnThe annualized rate of return is the percentage of return an investment provides yearly. It serves as a basis for comparison when the rate of return on short-term investments (i.e., the ones made for less than a year) are annualized.read more as compared to fund B. however if we compared the ratio of both the funds, the Calmar ratio of fund b is higher as compared to fund A. Hence fund A is riskier than fund B since it is more exposed to fluctuations in the NAV.

Advantages

It is one of the essential Ratios used by the Analyst and the Fund Managers to ascertain the performance of the Fund and compare the same with its peers who are giving high Returns. Below mentioned are some of the significant advantages :

  • It provides a clear picture on the risk and returns relationship in the fund to the investors to invest their money cautiously
  • It highlights the level of fluctuations or variations in the prices periodically giving a clear picture of the price stability of the fund
  • The higher the ratio, the more performing the fund and the lower the Calmar ratio, less performing the fund, and more prone to deviations or fluctuations.
  • It gives the fund manager an understanding of the fund performance and a signal about the funds with a low Calmar ratio and needs to be monitored further.
  • It gives an investor a guide in selecting their investment strategy as it also considers the drawdown that has happened in the past three years.

Disadvantages

Points to Note about Change in Calmar Ratio

  • A significant change in the Calmar ratio will suggest the ongoing performance of the fund and highlight the impact of the decisions taken in favor of or against the fund.
  • A sudden rise in the Calmar ratio is a positive sign for the fund as the same is less prone to risk and deviations in the prices/nav and has started performing better.
  • Alternatively, this implies for the sudden fall in the Calmar ratio. It signifies that either the performance of the fund is affected due to the annual rate of return or the maximum drawdown over the past three years.
  • As far as the investors are concerned, it would be better for them to stay away with the fund, which has experienced a sudden fall in the Calmar ratio. However, it may give higher returns and invest in the fund, which has shown a sudden increase in the Calmar ratio since the performance of the fund will now start improving in the long run.

Conclusion

Calmer Ratio is one of the essential tools to identify the correct fund to invest in for the investors and to monitor further the fund, which has a lower ratio from the fund managers’ point of view. However, other macro factors like govt policies, news elements, federal bank policies, and SEC regulations also need to be considered while deciding upon the fund performance instead of only considering the Calmar ratio for analysis and ignoring all other factors.

Finally, it is an excellent statistical tool to have a glimpse of the fund or the stock and its financial performance.

This has been a guide to what is Calmar Ratio and its definition. Here we discuss the formula of the Calmar Ratio along with examples, advantages, disadvantages, and limitations. You can learn more about financing from the following articles –

Reach out

Find us at the office

Exel- Frazzitta street no. 61, 44925 Kingston, Norfolk Island

Give us a ring

Jovanny Boeding
+23 274 947 142
Mon - Fri, 10:00-21:00

Tell us about you