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Maximum Drawdown
Definition
Maximum drawdown measures the worst cumulative loss an investor would have experienced from the highest point to the lowest subsequent point during a given period. For example, a maximum drawdown of 34% means the portfolio at some point declined by 34% from a prior peak before recovering. This metric is intuitive for committees because it matches how investors experience losses — not as abstract annual volatility numbers but as accumulated declines from recent highs. In Monte Carlo simulation, the maximum drawdown distribution across paths shows the range of worst cumulative losses possible under different market environments.
In the Context of Endowment Management
Maximum drawdown is often the risk metric that resonates most with investment committees because it connects directly to the experience of watching portfolio statements decline. Understanding the distribution of maximum drawdowns across simulation paths helps committees establish whether they have the risk tolerance to sustain their chosen allocation and spending policy through a severe bear market.