Sterling and Calmar Variants: Drawdown Return Ratios

Key Takeaways

• The Sterling Calmar ratio variants all divide return by some version of drawdown, differing only in the denominator.
• The Calmar ratio uses the single maximum drawdown, usually over a trailing 36 months.
• The original Sterling ratio uses average annual drawdown plus a fixed 10% cushion.
• Choosing average versus maximum drawdown changes how sensitive the ratio is to one extreme event.

What the Sterling Calmar Ratio Variants Are

The Calmar ratio, the Sterling ratio, and the MAR ratio are close cousins. Each divides a return figure by a drawdown figure, so a higher number means more reward per unit of decline. Where they part ways is the exact drawdown used.

The Calmar ratio uses the maximum drawdown, conventionally measured over a trailing 36-month window. The MAR ratio uses the maximum drawdown over the entire track record. The Sterling ratio uses an average of drawdowns rather than the single worst one, and its original form adds a fixed amount to that average. Understanding the variants prevents the common error of comparing two ratios that sound alike but measure different things.

The Intuition

A maximum drawdown is one observation, the worst the record happened to produce. That makes maximum-drawdown ratios sensitive to a single freak event. One unusually bad month can dominate the denominator and crush the score.

Averaging drawdowns smooths that out. The Sterling ratio takes the worst drawdown in each year and averages those yearly worsts, so no single event dictates the result. The trade-off is that averaging can hide a lone catastrophic loss that a maximum-drawdown measure would flag. Neither approach is universally right. The choice depends on whether you fear one disaster or a pattern of repeated declines.

How It Works

The three common variants share the same shape but swap the denominator:

Calmar ratio  = annualized return / maximum drawdown (trailing ~36 months)
MAR ratio     = CAGR / maximum drawdown (full track record)
Sterling ratio (original) = compound return / (average annual drawdown + 10%)

A modern Sterling form drops the fixed 10% and simply divides return by the average of yearly maximum drawdowns. Some versions subtract the risk-free rate from the return first, mirroring the Sharpe ratio, while others use the raw return.

The original 10% in the Sterling denominator has a specific history. Deane Sterling Jones built the ratio in 1981, when Treasury bills yielded about 10%. Adding 10% to the average drawdown made any strategy that scored above 1.0 look better than the risk-free alternative of the day. The cushion was an artifact of the rate environment, not a universal constant, which is why later users often drop it.

Worked Example

Suppose a fund returned 12% annualized. Over the period it had yearly worst drawdowns of 8%, 14%, and 11%, and a single all-time maximum drawdown of 20%.

Calmar ratio = 0.12 / 0.20 = 0.60, using the maximum drawdown.

Average annual drawdown = (8 + 14 + 11) / 3 = 11%. Modern Sterling = 0.12 / 0.11 = 1.09.

Original Sterling = 0.12 / (0.11 + 0.10) = 0.12 / 0.21 = 0.57.

Same fund, three numbers. The modern Sterling looks strongest because averaging dilutes the 20% worst case. The original Sterling looks weakest because the 10% cushion inflates the denominator. None is wrong, but quoting one without naming the variant invites confusion.

Common Mistakes

1. Comparing a Calmar ratio to a Sterling ratio directly. They use different denominators. A fund can beat a peer on Calmar and lose on Sterling, or vice versa.

2. Assuming the Sterling ratio includes the 10% cushion. Many modern tools drop it. Always confirm which definition a data provider uses before trusting the number.

3. Mismatching the lookback window. Calmar conventionally uses 36 months, but some platforms use other windows. A 12-month Calmar and a 60-month Calmar are not comparable.

4. Ignoring whether the risk-free rate is subtracted. Some variants use excess return, others raw return. The choice shifts every value, especially when rates are high.

5. Treating averaging as strictly safer. Average-drawdown variants can mask a single catastrophic loss. If surviving the worst case is your priority, a maximum-drawdown variant tells you more.

Frequently Asked Questions

What are the Sterling Calmar ratio variants in simple terms? The Sterling Calmar ratio variants are return-to-drawdown measures that differ only in how they define drawdown. Some use the single worst decline, others average several drawdowns.

How do the Sterling Calmar ratio variants affect investment decisions? They let you weight the kind of risk you fear most. A maximum-drawdown variant highlights one disaster, while an average-drawdown variant rewards consistency across years.

What is a real-world example of these variants? A fund with a 20% worst drawdown but milder yearly drawdowns scores 0.60 on Calmar yet over 1.0 on a modern Sterling. The same record, two very different impressions.

How can investors use these variants effectively? Always confirm the exact definition, including the lookback window, the 10% cushion, and whether returns are excess of the risk-free rate, before comparing two funds.

How are the Sterling and Calmar ratios different from each other? The Calmar ratio uses the single maximum drawdown, usually over 36 months, while the Sterling ratio uses an average of yearly drawdowns and historically added a fixed 10% to that average.

Sources

1. QuantifiedStrategies. "Sterling Ratio: Definition, Formula and Calculator." https://www.quantifiedstrategies.com/sterling-ratio/
2. RCM Alternatives. "Revealing the 10% in the Sterling Ratio." https://www.rcmalternatives.com/2014/03/revealing-the-10-in-the-sterling-ratio/
3. BarclayHedge. "Sterling Ratio." https://www.barclayhedge.com/research/definitions/Sterling-Ratio-definition.html
4. QuantifiedStrategies. "Calmar Ratio: Definition, Formula and Calculator." https://www.quantifiedstrategies.com/calmar-ratio/

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.