TY - JOUR T1 - Drawdowns JF - The Journal of Portfolio Management SP - 34 LP - 50 DO - 10.3905/jpm.2020.1.170 VL - 46 IS - 8 AU - Otto Van Hemert AU - Mark Ganz AU - Campbell R. Harvey AU - Sandy Rattray AU - Eva Sanchez Martin AU - Darrel Yawitch Y1 - 2020/08/31 UR - https://pm-research.com/content/46/8/34.abstract N2 - Common risk metrics reported in academia include volatility, skewness, and factor exposures. The maximum drawdown statistic is rarely calculated, perhaps because it is path dependent and estimated with greater uncertainty. In practice, however, asset managers and fiduciaries routinely use the drawdown statistic for fund allocation and redemption decisions. To help such decisions, the authors begin by quantifying the probability of hitting a certain drawdown level, given various return distribution properties. Next, they show that drawdown-based rules can be particularly useful for improving investment performance over time by detecting managers that lose their ability to outperform. This can happen as a result of structural market changes, increased competition for the type of strategy employed, staff turnover, or a fund accumulating too many assets. Finally, they show that drawdown-based rules can be used as a risk reduction technique, but this affects both expected returns and risk.TOPICS: Portfolio theory, portfolio construction, manager selection, wealth managementKey Findings• Drawdowns are particularly useful for detecting managers who have lost their ability to outperform. It is important to look at both drawdowns and overall performance measures such as Sharpe ratios. • Drawdown limits need to be dynamically adjusted to control for the length of time the assets have been managed. There is a greater chance for bad luck when the duration is longer.• When interpreting realized drawdowns, it is crucial to take the relative costs of Type I errors (firing good managers) and Type II errors (keeping bad managers) into account. Type I errors are particularly expensive if it is costly to find a new manager. ER -