appraisal ratio measure

The Appraisal Ratio is a performance measure used to evaluate the skill of an investment manager or portfolio in generating excess returns relative to a benchmark, taking into account the level of active risk taken. It assesses the manager’s ability to add value through active investment decisions.

The Appraisal Ratio is calculated by dividing the manager’s excess return (the difference between the portfolio return and the benchmark return) by the portfolio’s active risk (the standard deviation of the excess return). The formula for the Appraisal Ratio is as follows:

Appraisal Ratio = Excess Return / Active Risk

where:

• Excess Return is the difference between the portfolio return and the benchmark return. It represents the value added or subtracted by the investment manager through active management decisions.
• Active Risk is the standard deviation of the excess return, which measures the volatility or variability of the manager’s active investment strategy.

The Appraisal Ratio provides an indication of the manager’s ability to generate excess returns after adjusting for the level of risk taken. A higher Appraisal Ratio suggests better performance, as it indicates that the manager has generated a higher level of excess return relative to the level of active risk.

The Appraisal Ratio is particularly useful in evaluating actively managed portfolios or investment strategies, where the manager aims to outperform a specific benchmark by making active investment decisions. It helps investors and analysts assess the skill and effectiveness of the manager’s stock selection, asset allocation, and timing decisions.