What is an Appraisal Ratio?
An appraisal ratio is the ratio of aalpha to its risk.'s
How Does an Appraisal Ratio Work?
The formula for the appraisal ratio is:
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 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.