While other technical indicators, such as standard deviation, beta, alpha and r-squared serve as analytical tools that can be used to mathematically quantify and categorize certain characteristics of an investment, drawdown risk is a much more “real” measure of the potential impact that a substantial loss may have on your portfolio-and your life.

If that happens, will you be able to maintain your projected lifestyle in retirement without having to work for a while longer? If you are going to retire next year and 25 percent of your savings are held in an aggressive growth fund that has done very well over the past several years, then that fund may well be due for a substantial retracement. For example, a fund that can lose over half of its value in a short time and take years to recoup this is probably not very well managed.īut this kind of loss can be devastating for someone who is about to retire, and so this type of risk needs to be carefully assessed in order to gauge its potential impact in an investment portfolio. But some funds are able to recoup their losses much more quickly than others, and this can be a key indicator of how well the fund is managed. In most cases, the drawdown risk increases with a fund’s general risk and volatility. O’Reilly members experience books, live events, courses curated by job role, and more from O’Reilly and nearly 200 top publishers.Drawdown risk becomes more and more relevant to investors as they approach retirement age. Get Strategic Risk Management now with the O’Reilly learning platform. Unlike other metrics, such as volatility, and downside measures, like skewness or semi-variance, the maximum drawdown statistic crucially depends on the order in which the returns. The maximum drawdown statistic is appealing because it is unambiguous in its calculation and captures the most unfavorable investment outcome: buying at the peak and selling at the bottom. For example, for hedge fund investments, money is often pulled out when a threshold for the maximum drawdown is crossed. When evaluating managers or strategies, investors pay close attention to the maximum drawdown, which is the largest peak-to-trough return over the life of an investment.

In practice, however, asset managers and fiduciaries routinely use the drawdown statistic for fund allocation and redemption decisions. That is, conditional on a drawdown, is there information in drawdowns that could be useful for strategic portfolio management? In addition, how does the application of drawdown control impact portfolio expected returns? 1Ĭommon risk metrics reported in academia include volatility, skewness, and factor exposures, but the maximum drawdown statistic is rarely calculated, perhaps because it is path dependent and estimated with greater uncertainty. We now explore the information in the drawdown risk metric. Chapters 3 and 4 focused on two portfolio mechanisms that serve to reduce the severity of portfolio drawdowns: strategic rebalancing and volatility targeting.

Max drawdown meaning