What is an Appraisal Ratio?
An appraisal ratio is the ratio of a mutual fund's alpha to its risk.
How Does an Appraisal Ratio Work?
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.
Alpha and unsystematic risk values for specific funds can be found at: morningstar.com, tdameritrade.com, and other online broker sites.
Why Does an Appraisal Ratio Matter?
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.