What it is:
How it works/Example:
The formula for the appraisal ratio is:
Appraisal Ratio = Alpha / Fund's Unsystematic Risk
Let's assume Mutual Fund XYZ has an alpha of 0.06 and an unsystematic risk of 0.60. Using this information and the formula above, Mutual Fund XYZ's appraisal ratio is 0.06 / 0.60 = 0.01.
Why it matters:
The appraisal ratio measures a fund's return per unit of risk. However, the return in question is only alpha -- that portion of return generally attributed to the fund manager's stock-picking and fund-management skills. Thus, the appraisal ratio is a measure of how much return the fund manager brings to a fund per unit of risk. The risk in question is unsystematic risk -- that portion of risk associated with the risk of the investments rather than the risk associated with the entire securities market in general.