How to measure the performance of traders and money managers is one of the most underrated topic on the web. The simple reason is that there are a lot of people talking, but only few well grounded on the topic. I do not pretend to be an expert on it, but I have dealt enough with the topic to write a post on basic concepts. Also, being a trader and investor myself, I constantly struggle searching high risk adjusted performances. This post is going to be the first of a series where I deal with the topic of risk management.

Let ‘s dive right into the topic of performance measurement introducing the Calmar Ratio, its origin, definition. Then I’ll explain you why I deem it to be best measure of risk-adjusted performance for traders and money managers.

Short for California Managed Account Ratio, the Calmar Ratio was created by Terry W Young in 1991 and is also called the Drawdown ratio. Calmar Ratio is calculated as the Average Annual rate of return computed for the latest 3 years divided by the maximum drawdown in the last 36 months.

The calculation is done on a monthly basis. Maximum drawdown is calculated the largest peak to valley fall measurement in the given time frame. The higher the ratio, the better is the risk-adjusted performance of the trader or CTA in the given time frame of 3 years.

### How is the Calmar Ratio Useful?

Excellent risk-adjusted rates of return measure trading skill, the simple rate of return means nothing. Assuming you have a sum of $100,000 to invest and there are two CTA, one with a compounded annual return (CAR) of 35% and another with a CAR of 25%, it’s obviously more tempting to go in for the first fund whose return is higher. Here, it’s important to check the maximum drawdown of both funds; the first fund has a drawdown of 10% while the second has a drawdown of 5%. The Calmar Ratio of the first fund is 3.5 while that of the second fund is 5. This gives us a better picture of the prospects of both funds after accounting for risks. Now, the second fund seems a better prospect because the risk-adjusted return is higher. If you see the performance of large CTAs with high market reputation, you will notice that, though their returns seem good enough, the Calmar ratio of their managed futures funds will be relatively low, usually less than 2! This just goes on to prove that big isn’t always better. The fact is, drawdowns can be not only treacherous, but also unbelievably long; it could take months and sometimes, years to move on from a deep valley fall to get back to the peak. This is why the Calmar ratio calculated over a 3-5 year timeframe is more reliable than other data. While there are other similar ratios that predict returns after drawdown, the Calmar ratio is normally more reliable because it has a definite time-frame, is calculated on a monthly basis and allows for evening out over-achievement and under-achievement periods in the fund’s performance.

### Calmar Ratio, Sterling Ratio, Sharpe Ratio, Sortino Ratio or MAR Ratio?

There are several other effective and similar ratios that measure trading performance levels. The Sterling ratio, for instance, is computed by dividing compounded annual return by average maximum drawdown less 10%. The Sharpe Ratio is calculated by dividing compounded annual return by standard deviation of returns during a particular time period. The Sortino ratio is a variation on the Sharpe ratio; it analyses return beyond a desired target adjusted against downside deviation. Another ratio that’s often confused with the Calmar ration because of its name, is the MAR ratio. The MAR ratio is older than Calmar and is calculated by dividing annualised returns since inception by the maximum drawdown since inception. While each of these ratios have their own purpose and worth, I find the Calmar ratio to be the most convenient to use as well as the most effective way to measure risk-adjusted performance. Why?

- Firstly, the Calmar ratio is for a fixed time frame; mostly, 3 years. This will give you an idea of recent trends and performance of various traders or funds. If you’re only interested in long term and can’t be bothered with what’s happening now, you could go with the MAR ratio that calculated values since inception. However, if you want a picture of liquidity and immediate performance, the Calmar ratio is the best bet.
- The Calmar ratio is a definite number; just a look at this figure should give you an idea of a fund’s performance. For instance, a fund with a Calmar ratio of more than 5 is considered excellent, a ratio of 2 – 5 is very good and 1 – 2 is just good. A comparison of Calmar ratios of two funds is not required to determine their individual performances; this isn’t the case with other ratios like the Sortino or Sharpe ratio where the answer is meaningful only when you compare with other funds.
- Calmar ratio is based on actual drawdown, not volatility. Drawdown is a better measure of risk than volatility; drawdowns can be long and deep. Just measuring volatility doesn’t give a picture of the drawdown risk.
- Ratios that depend on volatility are extremely sensitive in the short run; market instability can cause these ratios to jump inanely. This is why Calmar ratio with its 3-year timeframe is more sensible.
- If you want a definite trend, the Calmar ratio again comes in handy. Since it gives a month on month statement, measuring the performance trend of various CTAs is easier and you could always judge which trader is in a downtrend at any particular point of time.
- Finally, in the words of Terry Young, “
*The Calmar ratio changes gradually and serves to smooth out the overachievement and underachievement periods of a CTA’s performance more readily than either the Sterling or Sharpe ratios.*” Now, we’ve established the fact that the Calmar ratio is a reliable measure to check the merit of different commodity trading advisors; U

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