## Maximum Drawdown

A risk metric indicating capital preservation, the maximum drawdown measures the peak-to-trough loss of an investment.

## How Is it Useful?

Maximum drawdown offers investors a worst case scenario. Maximum drawdown tells the investor how much would have been lost if an investor bought at the absolute peak value of an investment, rode it all the way down, and sold at rock-bottom.

Math Corner:

The calculation of maximum drawdown looks at all subperiods of the time period in question and calculates the compound return of the manager over each subperiod. The maximum drawdown is the lowest value of all these compound returns.

## Pain Ratio

A proprietary return-versus-risk trade-off metric, the pain ratio compares the added value over the risk-free rate against the depth, duration, and frequency of losses.

## How Is it Useful?

While one certainly wants to minimize losses, it is also important to make money. The pain ratio quantifies this trade-off into a single number. The pain ratio compares the gains over the risk-free investment against the losses that were suffered to obtain that return.

Math Corner:

The return element of the pain ratio is the annualized return of the investment in excess of the risk-free investment. Typically a short-term cash investment is used as the risk-free investment. The denominator of the pain ratio is the pain index, an integral measuring the depth, duration, and frequency of losses.

## Pain Index

A proprietary risk metric, the pain index quantifies the capital preservation tendencies of a manager or index. It measures the depth, duration, and frequency of periods of losses.

## How Is it Useful?

Losing money is a painful experience. The pain index attempts to measure the complete scope of losses. It addresses the shortcoming of only looking at maximum drawdown. It measures risk in terms of absolute returns.

## What Is a Good Number?

There is no hard-and-fast rule or breakpoint that separates a good pain index from a bad one. One must compare a manager’s pain index against an appropriate benchmark or peergroup in order to gain an understanding of whether a manager’s pain index is good or bad.

Math Corner:

The pain index is derived by calculating an integral measuring the area between a curve (e.g., the drawdowns) and the zero line separating periods of gains from losses. The integral is then divided by the length of the X-axis, representing the time frame.

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