What is an Appraisal Ratio?

An appraisal ratio can be used in different contexts to describe or measure the performance of a fund compared to the benchmark. The appraisal ratio also measures a mutual fund's alpha relative to its risk. This ratio also measures the performance of a fund manager by evaluating how his investment strategies are faring. The investment selection ability of a fund manager can be evaluated given the performance of the investments. Essentially, the appraisal ratio compares the alpha of a fund to its residual standard deviation otherwise known as risk. While the alpha is the amount of return an investment earns that surpasses the benchmark, the residual standard deviation measures the relative risk of the investment.

How Does an Appraisal Ratio Work?

The appraisal ratio is often used to determine how effective a fund manager's investment-selection ability is. It compares the performance of return of a given fund to the benchmark and also companies the return to the unsystematic risk. Generally, fund managers want to have returns that surpass the market benchmark, this goal informs their decisions when it comes to investment selection. The appraisal ratio gives an insight into the performance of a fund manager by examining the return of the selected investments against their underlying risks.