A Sydney prop desk ran three strategies simultaneously in 2022. Strategy A returned 28% annually. Strategy B returned 19%. Strategy C returned 11%. The desk allocated 60% of capital to Strategy A. By Q3, Strategy A had drawn down 41% — wiping out two years of gains. The highest raw return was also the highest destroyer of equity.

That desk ignored risk-adjusted metrics entirely. Raw return figures are seductive but structurally incomplete. A 28% return through a 40% drawdown is not the same engineering problem as a 19% return through an 8% drawdown. Comparing them without adjustment is like comparing bridge load capacity using only span length.

CONCEPTRisk-adjusted metrics quantify return per unit of pain — not just raw gain.
WARNINGAllocating capital by raw return alone is the fastest documented route to catastrophic drawdown.
KEY IDEAThree strategies with different raw returns can rank in reverse order once risk is factored in.

Three metrics do the structural work here. RAROC — Risk-Adjusted Return on Capital — divides net return by economic capital at risk, typically Value at Risk (VaR). The Sharpe Ratio divides excess return (above the risk-free rate) by annualised standard deviation. The Calmar Ratio divides annualised return by maximum drawdown. Each measures a different dimension of pain.

Risk-Adjusted Score by Strategy BucketScore0.51.01.52.0Strategy AStrategy BStrategy CRAROCSharpeCalmar

Applied to the three-strategy example: Strategy A scores a Calmar of 0.68 (28% return ÷ 41% drawdown). Strategy B scores 2.38 (19% ÷ 8%). Strategy C scores 1.38 (11% ÷ 8%). The ranking completely inverts. A rational capital allocation model — weighting by composite risk-adjusted score — would route the majority of capital to Strategy B, not Strategy A.

Institutional desks typically construct a composite score: weight RAROC at 40%, Sharpe at 35%, Calmar at 25%, reflecting that capital destruction (drawdown) and volatility both matter but capital preservation gets slight precedence. Strategy buckets scoring below 1.0 on any single metric trigger a hard capital cap — no more than 10% of total allocation regardless of raw return. This is the structural rule that stops the bridge from falling. Traders wanting deeper methodology can reference the RAROC framework on Investopedia, the Sharpe ratio on Wikipedia, and the Calmar ratio explained on Investopedia as starting references for building their own allocation models.

The number that looks best on a tearsheet is rarely the number that survives contact with a real drawdown. Measure the pain, then allocate the capital.

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