Yao Hua Ooi isn’t a trained psychologist, but as an investor who relies on human behavioral patterns to craft investment strategy, he employs a lot of the same skills. Ooi, along with co-portfolio managers Brian Hurst and Ari Levine, run the day-to-day operations of the $7 billion AQR Managed Futures Strategy Fund, one of the growing roster of alternative mutual funds and ETFs that trade futures contracts—agreements to buy or sell an asset in the future at a set price—and packages them into a liquid, tradable product.


The managers use “trend following,” a quantitative strategy based on predictable human investment-related behaviors, to determine where to place their bets. By identifying and exploiting sustained asset flows into and out of markets driven by such behaviors, they aim to benefit from broad and sustained market trends.

To capture returns whether markets go up or down, Ooi and his colleagues will sell short futures contracts if their indicators show a declining price trend and hold a long position if they believe prices will be rising. They apply the strategy to 100 or so different positions in the equity, fixed income, currency and commodities markets. Over the long term, the goal is to spread risk in roughly equal proportion across the four asset categories, although the fund may overweight one or more types of assets if a trend is particularly strong or underweight if a trend is weak.

The foundation of the fund’s blend of psychology and quantitative investing is how individuals adjust to new information. One of the best known of these behavior patterns is “anchoring,” or the tendency to hold tenaciously to views and adjust slowly to new information. This can cause prices to underreact to news. The “disposition effect” occurs when investors sell winners too early and ride losers too long, which slows down price adjustments. People who succumb to the “herding effect” jump on the bandwagon when prices have moved in one direction for a while, a behavior that has been blamed for market bubbles.

While trend following strategies and the managed futures funds that use them have been around for decades, they haven’t done as well as the equity markets over the last few years. According to Morningstar, the average managed futures mutual fund saw annualized returns of 0.06% over the three years ended December 31, while the Standard & Poor’s 500 index returned 20%.

With annualized returns of 7.3% over the last three years, Ooi’s fund has done better than most of its competitors. He and his co-managers garnered the Morningstar Manager of the Year award for alternative investments in 2013, a year in which the fund delivered a return of 9.4%–and the average managed futures fund delivered 1%. One reason analysts give for AQR’s superior performance in recent years is that it has maintained a higher weighting in U.S. equities than many of its rivals.


The main reason for the comparatively poor performance of managed futures funds against the stock market in recent years lies in the nature of trend investing, says Ooi. “The strategy does best when markets exhibit persistent trends, when they are going from good to great or bad to worse. But if the market lacks clear trends or has had sharp reversals, trend following does not work as well. Since 2009, there have been sharp reversals across a number of markets, and those markets have been more highly correlated to each other than they have been in the past.” When markets move together, the fund has fewer independent trends to follow among the four different asset classes it covers.

But he stresses the goal of the fund is to add diversification and a source of uncorrelated returns to portfolios, not stretch for outsized returns in equity bull markets. “Media attention has been focused on the underperformance of managed futures over the last few years against the stock market,” says the 32-year-old manager. “But a lot depends on when comparisons are made, and what they are made against.”

Several studies document the value of managed futures as a long-term diversifier with a very low correlation to stocks, bonds and other investments. These studies also show strong evidence that the ability to identify market downturns early on and take short positions has given managed futures the edge during times of extreme stock market stress. That happened in 2008, when the compounded return for managed futures was 18.33%, compared with a 37% drop for the Standard & Poor’s 500 index, according to the Managed Funds Association. During the “lost decade” for stocks between 2000 and 2009, managed futures earned an annualized return of 6.76%, while the S&P suffered an annualized loss of 0.95% and the Nasdaq fell an average of 5.67% annually.

They also stacked up well against other alternative investments during the bear market between August 2007 and December 2008, according to a 2014 study published by CME Group. During that period, an index representing hedge funds fell over 17%, while indexes reflecting private equity investments and real estate investment trusts plummeted 70.42% and 47.2%, respectively. By contrast, the BTOP 50, a managed futures index, gained 17.7% over the period.

The study also showed that the BTOP 50 outperformed the S&P 500 index in all of the 15 worst quarters for the market since 1987. The starkest contrast was in the fourth quarter of 1987, a period following “Black Monday” in which the S&P 500 fell 22.5% and the BTOP rose 16.88%. During the dot-com bubble burst in the fourth quarter of 2000, the S&P 500 lost nearly 8%, while the BTOP rose nearly 20%.

“For financial advisors, a core challenge is having heavy equity risk,” says Ooi. “Many have experienced large declines that have been very damaging to portfolios, and managed futures can be immensely helpful under such conditions.”



Simply diversifying into alternative investments such as commodity or currency ETFs isn’t enough because they can’t profit from bear markets. And investors who use put options to limit downside risk run up against high costs that make the strategy unviable. He considers a 5% to 15% allocation within a portfolio toward managed futures as “a healthy level” at which uncorrelated returns can make a dent in overall portfolio performance.

A common criticism of managed futures funds is their high costs. Investors in private funds specializing in managed futures typically pay a “2 and 20” fee structure in which investors pay a 2% annual management fee and an additional fee of 20% on any profits.

Fees are somewhat more palatable in the mutual fund world, though the cost of running the strategy and frequent trading makes the fees here higher than they are in the average equity fund. AQR Managed Futures is able to keep its net expense ratio to a relatively tame 1.25% for Class I shares and 1.50% for Class N shares (including an expense cap that runs until April 30, 2015), in part because the firm manages the strategy in-house rather than farm the work out to sub-advisors, as many of its competitors do.

Like those in any mutual fund, the trading fees here aren’t reflected in the expense ratio, and in these high-turnover funds, they can add up. While Ooi declines to put a number on trading costs for the fund, he notes that the firm employs proprietary trading algorithms to minimize them. A research paper he wrote in 2013 for the Journal of Investment Management placed transaction costs for managed futures funds “in the order of 1% to 4% per year for a sophisticated manager.”

Whether or not that observation applies specifically to the fund, the sophisticated manager label certainly applies to Greenwich, Conn.-based AQR Capital, which runs a massive $115 billion in a variety of alternative investment strategies. About $16 billion of that comes from the mutual funds, which were launched in 2009.

Clifford Asness, David Kabiller, Robert Krail, and John Liew founded the firm in 1998. Asness, the most visible of the group, makes frequent media appearances and penned an article in Financial Advisor, much of which was excerpted from his e-book, Bubble Logic, in 2001 that won award from the CFB Board of Standards. Before launching AQR, he was the former director of quantitative research for Goldman Sachs’s Asset Management Division. Together with his colleagues, AQR principals have produced an impressive body of research on quantitative investing that has been published in a number of respected financial journals.

Ooi joined the firm 10 years ago after graduating from the University of Pennsylvania with degrees in economics and engineering and began co-managing the fund in 2010 at age 28.

Although the environment for managed futures hasn’t been ideal for much of the fund’s existence, Ooi says the prolonged bull market for stocks and bonds and the possibility of a downturn makes a case for diversifying and making an allocation to managed futures. And in an encouraging sign for trend followers, the markets began to exhibit more trends in the last two years (2013 and 2014) and fewer of the choppy fits and starts that have dominated since 2009.

“In 2014, there were pronounced trends in the strengthening of the U.S. dollar against other currencies and a decline in commodity prices, and [there were] decently positive trends in the global equity and fixed-income markets,” he says. While that doesn’t necessarily mean strong trends will prevail in 2015, Ooi points out that “over the long term, markets tend to trend more often than not.”