Due to the presence of actuator disturbances and sensor noise, increased false alarm rate and decreased fault detection rate in fault diagnosis systems have become major concerns. Various performance indexes are proposed to deal with such problems with certain limitations. This paper proposes a robust performance-index based fault diagnosis methodology using input–output data. That data is used to construct robust parity space using the subspace identification method and proposed performance index. Generated residual shows enhanced sensitivity towards faults and robustness against unknown disturbances simultaneously. The threshold for residual is designed using the Gaussian likelihood ratio, and the wavelet transformation is used for post-processing. The proposed performance index is further used to develop a fault isolation procedure. To specify the location of the fault, a modified fault isolation scheme based on perfect unknown input decoupling is proposed that makes actuator and sensor residuals robust against disturbances and noise. The proposed detection and isolation scheme is implemented on the induction motor in the experimental setup. The results have shown the percentage fault detection of 98.88%, which is superior among recent research.