Risk Unlocked: Drawdown and its types
There are various measures of risks in the investment world; some are so mathematical that a common investor cannot relate to them. Nonetheless, there are some simple measures of risk, one such measure is a drawdown, which is any continuous losing return period. It is also known as a reduction on one’s capital after a series of losses. This is normally calculated by getting the difference between capital at a relative peak, minus the capital at a relative trough.
For example, if you have invested certain capital and your capital after the cumulative return is Rs. 1,00,000. If it drops to Rs. 50,000 due to a series of losing trades, your drawdown is 50 per cent.
We have taken the example of ICICI Prudential Focused Equity Fund for the period between 30-08-2016 and December 4, 2018 to calculate all the above drawdowns.
Average drawdown
As its name suggests, the average drawdown is the average continuous negative return over an investment period. This investment period can vary from 3 to 5 years. Another way to define it is to find the average of the top few drawdowns. For example, the average of the top five drawdowns.
The average drawdown is 2.14% in the above case.
Maximum drawdown
It is fairly simple and is defined as the largest cumulative loss of a portfolio within a given time interval. The maximum drawdown should not be confused with the largest individual drawdown, which is the maximum potential loss over a specific time period, typically 3 years. Maximum drawdown represents the maximum loss an investor can suffer in the fund, buying at the highest point and selling at the lowest. Like any other statistics, it is essential to compare performance over the same time period.
The maximum drawdown in the above example is 10.51 per cent between September 9, 2016, to November 21, 2016.
Largest individual drawdown
As the name suggests, the largest individual drawdown is the largest individual uninterrupted loss in a return series.
Recovery Time or drawdown duration
The recovery time or drawdown duration is the time taken to recover from an individual or maximum drawdown to the original level.
In our above example, it took 77 days to recover from the lowest point. It attended the previous high only on March 14, 2017.