![]() ![]() We use maximum drawdown as one of the key statistics for evaluating our quantitative investment strategies and for deciding on the introduction of new variables in our models. Most investors would strongly prefer the first strategy, because it has a much lower maximum drawdown than the second strategy! Furthermore, the length of the drawdown period is shorter. However, the maximum drawdown can also be calculated based on returns relative to a benchmark index, for identifying strategies that show steady outperformance over time.įor example: two strategies can have the same average outperformance, tracking error, information ratio and volatility, but their maximum drawdowns compared to the benchmark can be very different.įor instance, suppose that the first one achieves a monthly performance of 1%, -0.5%, 1%, -0.5% and so on versus the benchmark, while the second strategy achieve an outperformance of 1% each month during the first half of the sample, but an underperformance of 0.5% each month during the second half of the sample. The maximum drawdown can be calculated based on absolute returns, in order to identify strategies that suffer less during market downturns, such as low-volatility strategies. It is usually quoted as a percentage of the peak value. ![]() For context of how tough the pandemic market crash was, we have also included the FTSE JSE Capped SWIX index to represent the SA equity market maximum drawdown.Maximum drawdown is defined as the peak-to-trough decline of an investment during a specific period. For example, for hedge fund investments, money is often pulled out when a threshold for the maximum drawdown is crossed. The maximum drawdown or worst loss an investor could have experienced in the case of investing in each individual fund and the combination is summarised in order below. close attention to the max-imum drawdown, i.e., the largest peak-to-trough return over the life of an investment. This phenomenon is illustrated in the chart on the right where the four portfolios’ maximum drawdowns are shown by the lines, and the combination of the four funds is shown by the grey shadow area. Risk measures based on the maximum drawdown can serve as an alternative to the commonly used Value-at-Risk. Maximum drawdown has been extensively studied in the recent literature. ![]() Right: Drawup (blue) and maximum drawup (black) of S&P500 in 2005. In essence, the maximum drawdown of the whole is greater (or less negative) than the sum of the parts. Center: Drawdown (blue) and maximum drawdown (black) of S&P500 in 2005. What is less understood and expected is that the maximum drawdown of the combined funds can be less than any of the underlying funds. This is logical and something generally understood. The combined series of returns results in a return that will sit somewhere between the four underlying funds, depending on how they are weighted over time. What is vital is the result when these funds are combined into an equally weighted series. These four funds have the correlation relationship between them as illustrated by the matrix below. UBS Global Allocation Fund has a Maximum Drawdown of 48.7 and annual return of 2.6. Take four different funds: a Flexible Fund, a High Equity Multi-Asset fund, an Africa Bond Fund and a Hedge Fund. Vanguard LifeStrategy Growth Fund has a Maximum Drawdown of 47.6 and annual return of 4.7. There is a way to reduce one’s maximum drawdown as we will illustrate below. Understand how to find the max drawdown of an investment, and also review what the drawdown risk is. Withdrawing from the fund can result in locking in a maximum loss if the liquidity requirement unfortunately coincides with the bottom of the performance cycle. Learn what the drawdown of an investment or a fund is. A lower correlation between zero and one indicates that the funds move in different directions more frequently and a correlation close to one suggests they perform positively simultaneously and negatively simultaneously.Īnother statistic that is particularly relevant to investors who withdraw some of their capital is the maximum drawdown on a fund. My final caveat is that the next bear market will be different from the previous one, so max drawdown will not be a. We refer to the relationship between the performance of the funds as their relative correlation. We expect to add max drawdown to fund data pages later this year, so stay tuned. The benefit of understanding this allows one to mix and match funds that behave differently at different points in the market cycle. This translates into how the fund is likely to perform through the cycle. When putting together a portfolio of funds, one needs to consider the investment style, philosophy and process of the manager running the fund. A maximum drawdown (MDD) -or max drawdown- is the most observed loss when the funds in a portfolio are measured from their peak to their trough, prior to a new. One of the free lunches in life is diversification. ![]()
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