Understanding the Correct Metrics for Calculating Maximum Drawdown of a Fund
The Importance of Using the Right Metrics for Calculating Maximum Drawdown
When evaluating the performance of a fund, it's crucial to understand the correct metrics to use for calculating its maximum drawdown. This article aims to clarify the distinction between using net asset value (NAV) and accumulated unit value (AUM) for this purpose. Properly measuring maximum drawdown ensures that investors can accurately assess the potential risk and volatility associated with their investments.What Is Maximum Drawdown?
Maximum drawdown (MD) is the peak-to-trough decline of an investment during a specific period. It's a key metric for understanding the amount of potential loss an investor can experience. MD is calculated based on the performance of a fixed initial investment and is not influenced by the total assets under management (AUM) of the fund.Why Use Accumulated Unit Value (AUM) over Net Asset Value (NAV)?
Net asset value (NAV) and accumulated unit value (AUM) are often used interchangeably, but they serve different purposes. For the purpose of calculating maximum drawdown, it is essential to use accumulated unit value. Here are the reasons why: NAV vs. AUM: NAV represents the per-share value of a fund, while AUM refers to the total value of all assets under management. Fixed Initial Investment: When calculating maximum drawdown, the focus should be on the value of a fixed initial investment, not the overall AUM of the fund. Accurate Risk Assessment: AUM can be misleading because it can increase or decrease based on market conditions or inflows, which do not reflect the true risk profile of an investor's initial investment.Example of Calculating Maximum Drawdown
To illustrate the importance of using AUM over NAV, consider the following scenario:If an investor initially invested $1 in a fund that hit a high of $3 but is now worth $2.70, the maximum drawdown would be 10% (3 - 2.70 0.3, 0.3 / 3 0.10 or 10%). The AUM of the fund might have increased from $1 billion to $1.5 billion due to inflows, but this does not affect the investor's drawdown, which is based on the fixed initial investment.