Please ensure Javascript is enabled for purposes of website accessibility

What Is the Calmar Ratio?

By Motley Fool Staff – Jul 22, 2016 at 11:01PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Here's a helpful tool for calculating risk.

All investments come with a degree of risk, and having a way to measure that risk is an important part of making a sound investment decision. That's why many investors find the Calmar ratio so useful. The Calmar ratio is a formula used to measure a hedge fund's performance relative to its risk. It's calculated by taking a hedge fund's average annual rate of return, typically over a three-year period, and dividing it by the fund's maximum drawdown.


Annual rate of return

The annual rate of return indicates how a hedge fund has performed over the course of a year. It shows the extent to which a fund's portfolio has gained or lost value, as expressed as a percentage.

Maximum drawdown

Maximum drawdown, as it relates to a hedge fund, is a measure of the fund's maximum loss from its peak value. It is calculated by subtracting the fund's lowest value from its peak value, and then dividing that figure by the peak value.

Let's say a fund's portfolio starts out being worth $100,000. It then increases to $200,000, drops to $90,000, increases to $150,000, and then drops down to $80,000 before eventually climbing back up to $200,000. In this case the maximum drawdown would be 60%, calculated as follows:

($200,000-$80,000)/$200,000 = 60%

Calculating the Calmar ratio

To arrive at a fund's Calmar ratio, we take its average annual rate of return over the past three years and divide it by the fund's maximum drawdown over that same time period. So if a fund's average annual rate of return is 50% and its maximum drawdown is 25%, its Calmar ratio is 2.

Uses of the Calmar ratio

The Calmar ratio measures a fund's performance on a risk-adjusted basis. A higher Calmar ratio indicates that a fund's return has not been at risk of large drawdowns. A lower Calmar ratio, on the other hand, suggests that the drawdown risk is higher.

The Calmar ratio is an important tool when comparing the return of two different funds. Let's say Fund A has an average annual rate of return of 40%, and Fund B has an average annual rate of return of 50%. As an investor, you might be inclined to automatically go with Fund B, since it's average annual rate of return is higher. However, if Fund A's Calmar ratio is higher, you may be better off choosing Fund A over Fund B. The reason? Though Fund B has a better return than Fund A, a lower Calmar ratio means that Fund B may be a riskier prospect.

In other words, if you invest in Fund B, you might stand to gain more than if you were to invest in Fund A. However, you also stand to lose more. The purpose of the Calmar ratio is to illustrate the level of risk taken to achieve a return. Different investors have varying tolerances for risk, but the Calmar ratio can help you align your appetite for risk with the investment choices you're presented with. 

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at [email protected] . Thanks -- and Fool on!

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Nearly 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now


Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/08/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.