  In the past 20 years, momentum or trend following strategies have become an
established part of the investor toolbox. We introduce a new way of analyzing
momentum strategies by looking at the information ratio (IR, average return
divided by standard deviation). We calculate the theoretical IR of a momentum
strategy, and show that if momentum is mainly due to the positive
autocorrelation in returns, IR as a function of the portfolio formation period
(look-back) is very different from momentum due to the drift (average return).
The IR shows that for look-back periods of a few months, the investor is more
likely to tap into autocorrelation. However, for look-back periods closer to 1
year, the investor is more likely to tap into the drift. We compare the
historical data to the theoretical IR by constructing stationary periods. The
empirical study finds that there are periods/regimes where the autocorrelation
is more important than the drift in explaining the IR (particularly pre-1975)
and others where the drift is more important (mostly after 1975). We conclude
our study by applying our momentum strategy to 100 plus years of the Dow-Jones
Industrial Average. We report damped oscillations on the IR for look-back
periods of several years and model such oscilations as a reversal to the mean
growth rate.
