In the hedge fund industry, return over maximum drawdown is the best measure of how well the fund manager has managed risks. It measures the average return of a portfolio over its worst loss, or “maximum drawdown.”
This is a relatively new indicator for managers to track and compare since the industry only started tracking this statistic in the 1990s. The drawdown must be observed from the peak profit or peak value of equity. A drawback of the return over maximum drawdown metric is that it does not directly measure how profitable returns are, but rather measures how well a hedge fund has managed risks.
So now let’s find out what is “Return over Maximum Drawdown”.
What is the Return over Maximum Drawdown
Return over maximum drawdown is a risk metric used in the hedge fund industry, which measures how well the fund managers have managed risk. It measures the average return of an investment over its worst loss since the beginning of the period under consideration. The drawdown must be calculated from the peak value or peak profit.
How to calculate the Return over Maximum Drawdown
To calculate the return over maximum drawdown, start by getting the average return on investment. Then, get its worst loss or maximum drawdown. Next, divide the two to find the return over maximum drawdown. The drawback to this measurement is that it only measures how well an investment manager has managed risks and does not directly measure how profitable returns are.
For example, imagine that an investment has a -15% maximum drawdown and averages +25.2%. Return over maximum drawdown would be 25.2% /15% = 1.68
In this example, the return of investment is higher than its worst loss or maximum drawdown, which means it had a good risk management system compared to other investments.
Benefits of Return over Maximum Drawdown
The main benefit of return over maximum drawdown is that it’s a relatively new measure used in the hedge fund industry, which first started tracking this statistic in the 1990s. Many investors use the return over maximum drawdown to compare how different investment managers manage risks. Here are some benefits of Return over Maximum Drawdown:
- It’s a relatively new measure, so it has only been tracked in the hedge fund industry since the 1990s.
- Good risk management is best measured by return over maximum drawdown because it measures how well an investment manager has managed risk, rather than the profitability of returns.
- Return over maximum drawdown can be used to compare investments and compare how different investment managers manage risk.
- Return over maximum drawdown can be used as a benchmark for performance since it is a relatively new performance metric.
Drawbacks of Return over Maximum Drawdown
There are some drawbacks of the Return over maximum drawdown
- It is only a measure of risk and does not directly measure profitability even though it can be used as a benchmark for performance.
- In order to use the return over maximum drawdown, there must be at least 12 months of historical data available to calculate statistics.
- Return over maximum drawdown becomes less reliable at the extremes of the range, which makes it difficult to use for very risky or very safe investments.
Conclusion
Return over maximum drawdown is a risk metric used in the hedge fund industry, which measures how well investment managers have managed risk. It measures the average return of an investment over its worst loss since the beginning of the period under consideration. The drawback to this measurement is that it only measures how well an investment manager has managed risk and does not directly measure how profitable returns are. Return over maximum drawdown can be used to compare investments and to measure performance, but it does not directly measure profitability.
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