KPI of the Day – Investment: # Appraisal ratio
Definition
Measures the amount of risk a fund manager takes, based on the selected stocks, by comparing the fund’s adjusted return, assuming the market return is zero, to the portfolio’s unsystematic risk.
Purpose
To evaluate the quality of a fund’s investment picking ability.
Recommendations
Financiers are commonly very particular about the quality of a fund’s investment. One of the ways to do so is by assessing the # Appraisal ratio indicator. The # Appraisal ratio helps measure the financier’s performance by comparing the return of their stock picks to the specific risk in the investment basket.
The lower the ratio, the worse the performance of the investment portfolio. Financiers, especially hedge fund managers, are expected to make sound financial decisions regarding their investments. Mutual funds, bonds, and stocks should yield positive results on the long run.
Financiers should also be able to gather relevant data in comprehensive portfolios that are further presented to investors and stakeholders. Therefore, the key is to employ professional and skilled human capital, supported by technology through automation and digitization.
Several other recommendations to increase the # Appraisal ratio include, but are not limited to, the following:
- High quality risk analysis of investments through various approaches, such as manual calculations and formula automation;
- Making use of the # Appraisal ratio together with other indicators, such as the % Portfolio yield indicator;
- Training financiers and managers to regularly be up-to-date with technology and new methodologies in assessing investment risks;
- Ensuring thorough and comprehensive portfolio presentations to the investors to increase confidence and reduce risk of withdrawals.
A high KPI is interpreted as superior performance, because it indicates a high probability of a positive return, after subtracting financing costs and neutralizing the risks associated with the benchmarks.
Maximizing this KPI is necessary for maximizing the Sharpe ratio, a widely used measure of fund performance. For a hedge fund, the ratio of the fund is itself the Sharpe ratio of the hedged position that neutralizes the benchmark risk.
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Tags: Investments, KPI
