Why return alone is not enough

Imagine two strategies. Strategy A returns 22% CAGR but fell 65% during the 2020 COVID crash and took 3 years to recover. Strategy B returns 18% CAGR with a maximum drawdown of 28% and recovered in 8 months. Most investors would prefer Strategy B even though it returns less — because surviving a 65% drawdown emotionally and financially is genuinely difficult.

Risk-adjusted metrics quantify this trade-off so you can compare strategies fairly.

CAGR — the headline number

Compound Annual Growth Rate (CAGR) tells you the annualised return assuming growth compounds year over year. If a strategy turned ₹100 into ₹300 over 10 years, the CAGR is approximately 11.6%.

CAGR is useful for comparing overall wealth creation but tells you nothing about how smooth or volatile the journey was.

Sharpe Ratio — return per unit of total risk

The Sharpe ratio measures how much excess return you earned per unit of total volatility (standard deviation of returns). The formula is:

Sharpe = (Strategy Return − Risk-Free Rate) / Standard Deviation of Returns

In Indian context, the risk-free rate is typically the 91-day T-bill yield, roughly 6–7% currently.

A Sharpe of 1.0 means you earned 1% of excess return for every 1% of volatility. In practice:

The NIFTY50 index itself has historically had a Sharpe ratio of around 0.5–0.7 over long periods.

Sortino Ratio — penalising only downside volatility

The Sortino ratio is similar to Sharpe, but instead of dividing by total standard deviation, it divides by downside deviation — the standard deviation of only negative returns. This is intuitively better: investors dislike losing money but don't mind high upside volatility.

A strategy with a Sortino ratio significantly higher than its Sharpe ratio is one where most of its volatility is to the upside — generally a good sign. A Sortino close to the Sharpe suggests returns are symmetrically volatile (equal upside and downside swings).

Maximum Drawdown — your worst-case scenario

Maximum drawdown (MDD) is the largest peak-to-trough decline in portfolio value during the backtest period. If the portfolio was worth ₹100 at its highest point and fell to ₹45 before recovering, the MDD is 55%.

This number is critical for two reasons:

  1. Psychological durability — can you actually hold through a 50% drawdown without selling at the bottom? Most people cannot. A strategy you can't hold is a strategy that doesn't work for you.
  2. Recovery time — a 50% drawdown requires a 100% gain just to break even. If recovery takes 3 years, you've lost 3 years of compounding.

What is a reasonable MDD for NSE strategies?

The NIFTY50 index itself suffered a ~60% drawdown during 2008 and ~38% during the 2020 COVID crash. A strategy with NIFTY200 exposure during similar periods will likely see comparable or higher drawdowns unless it has explicit risk controls.

For long-only Indian equity strategies, a maximum drawdown of 30–45% is typical over a 10+ year backtest that includes 2008 or 2020. Anything significantly lower warrants scrutiny — it may indicate the strategy missed the crash period or is overfitted to smooth data.

Calmar Ratio — CAGR divided by max drawdown

The Calmar ratio is simply CAGR divided by maximum drawdown (expressed as a positive number). It tells you how much annual return you earn per unit of worst-case risk. A Calmar of 0.5 means a strategy with 20% MDD earned about 10% CAGR.

Information Ratio — consistency of alpha

The information ratio measures how consistently a strategy beats its benchmark. It is the ratio of excess return over the benchmark to the tracking error (the standard deviation of excess returns). A high information ratio means the strategy beats the benchmark reliably, not just in a few lucky years.

Reading metrics together

No single metric tells the full story. The right approach is to read them as a system:

See all metrics on your backtest results

ftInvstr shows CAGR, Sharpe, Sortino, Calmar, max drawdown, and information ratio together — so you can evaluate strategies properly.

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