Worked examples
The following examples will explain some strengths and weaknesses of the Calmar ratio. I've modeled three theoretical funds. For example, Fund C gained 25% in its first year and then 45% in its second year, but lost 33% in its third year. The average return of the fund over three years is, therefore, 12%. Meanwhile, the peak of the fund is at the end of the second year, and since the fund lost 33% in its third year, the maximum drawdown (from peak to trough) is 33%. The Calmar ratio is simply the average return of 12.3% divided by the maximum drawdown of 33%, so it works out to 0.37.
As you can see below, Fund B has the highest score and is deemed the best fund, followed by Fund A and then Fund C. I have a few observations that will help demonstrate the strengths and weaknesses of the Calmar ratio.
First, reporting periods matter significantly in the alchemy of asset manager performance. For example, Fund C has the worst Calmar ratio but can present the best returns numbers after the second year. As such, it's essential to back-test the funds' returns for as long as possible and across different market conditions. In my opinion, a three-year reporting period is woefully inaccurate in measuring fund metrics. More data is better when it comes to performance measurement, and for argument's sake, I think any backtesting should cover at least the last couple of recessions.
Second, Fund A is slightly superior to Fund C despite offering far less return. In other words, the Calmar ratio is telling you to prefer Fund A with its 2% annual return over Fund C with 12%. That's fine if you don't want to tolerate the downside risk in Fund C, but it's not a conclusion that will suit all investors.
Third, Fund B is superior to Fund A despite having a larger maximum drawdown. As such, the ratio represents the viewpoint of an investor willing to sacrifice some drawdown in favor of generating returns.
