Commodity Pools: Leveraging Collective Power in Commodities Trading
18 February, 2023
The commodities market is a vast universe, with different segments and risk levels involved. For many investors who trade commodities, a key issue is managing the market’s inherent high volatility. For others, a key issue is entering this market in the most low-risk fashion possible. For all these types of traders, commodity pools might be an excellent solution.
In this article, we cover these pools and define their main advantages and disadvantages. Before placing your next commodity trade or opening a brokerage account, consider the commodity pool structure as a viable alternative to going solo.
In this article, we cover these pools and define their main advantages and disadvantages. Before placing your next commodity trade or opening a brokerage account, consider the commodity pool structure as a viable alternative to going solo.
What Is a Commodity Pool?
A commodity pool is a financial vehicle that pools together contributions from multiple investors and uses the collected funds to trade various commodity products — typically futures and options. Commodity pools are designed to leverage the collective power of many investors for profitable trading, risk minimization, and access to a wider range of opportunities on commodity markets.
Commodity pools operate as private investment vehicles. They are often referred to as managed futures funds. However, they are not completely synonymous with managed futures funds and rather represent one variety of them.
Commodity pools are set up and run by commodity pool operators (CPOs). CPOs, in most cases, need the accreditation of a commodity trading advisor (CTA). Most commodity pools need to be registered with the Commodity Futures Trading Commission (CFTC), the primary regulator of the futures market in the US.
Some smaller commodity pools are exempt from the CFTC registration requirements. These are pools with fewer than 15 investors and $ 400,000 in assets under management (AUM). Some other pools exempt from the CFTC registration requirement include small single-commodity pools where the CPO doesn’t receive compensation. In general, unless a commodity pool has a very limited size and scope, CFTC registration is required.
Commodity pools operate as private investment vehicles. They are often referred to as managed futures funds. However, they are not completely synonymous with managed futures funds and rather represent one variety of them.
Commodity pools are set up and run by commodity pool operators (CPOs). CPOs, in most cases, need the accreditation of a commodity trading advisor (CTA). Most commodity pools need to be registered with the Commodity Futures Trading Commission (CFTC), the primary regulator of the futures market in the US.
Some smaller commodity pools are exempt from the CFTC registration requirements. These are pools with fewer than 15 investors and $ 400,000 in assets under management (AUM). Some other pools exempt from the CFTC registration requirement include small single-commodity pools where the CPO doesn’t receive compensation. In general, unless a commodity pool has a very limited size and scope, CFTC registration is required.
Advantages of Using Commodity Pools
Advantage 1: A good entry point for retail traders to the commodity market. The commodity marketis known for its dominance by large players, investment firms and commodity businesses. For many retail investors, competing against the big boys on their own is difficult. By pooling their funds together with other investors, retail traders can leverage the collective power in the market.
Advantage 2: More diversification opportunities. Commodity pools may be able to allocate their investment across a more diverse range of commodity products than many traders could on their own. A pool managing a total of $ 10 million from 100 investors will likely have more diverse options on its hands than a commodity trader with $ 100,000. The better diversification will serve as an important risk hedge, something that is extremely useful given the volatility of the commodities market.
Advantage 3: Strong regulatory protections. In most cases, commodity pools are highly regulated investment vehicles. With the exception of the smallest pools, most commodity pools and CPOs must be registered with the CFTC. For less experienced investors, these regulatory protections make the larger commodity pools a much safer option than going solo and ending up with an unscrupulous, fraudulent broker.
Advantage 4: Tax benefits. Regardless of how long you’ve held an investment in a commodity pool, you will be taxed on capital gains using the "60/40" rule. Under this rule, 60% of your gains will be taxed at the long-term capital gains rate, which for most investors is lower than the short-term rate. Only 40% will be taxed at the typically higher short-term capital gains rate. This rule is beneficial to commodity traders who prefer to hold on to their investments for less than 12 months. As such, it is great for active commodity traders who usually place trades with short-term and medium-term intents.
Advantage 2: More diversification opportunities. Commodity pools may be able to allocate their investment across a more diverse range of commodity products than many traders could on their own. A pool managing a total of $ 10 million from 100 investors will likely have more diverse options on its hands than a commodity trader with $ 100,000. The better diversification will serve as an important risk hedge, something that is extremely useful given the volatility of the commodities market.
Advantage 3: Strong regulatory protections. In most cases, commodity pools are highly regulated investment vehicles. With the exception of the smallest pools, most commodity pools and CPOs must be registered with the CFTC. For less experienced investors, these regulatory protections make the larger commodity pools a much safer option than going solo and ending up with an unscrupulous, fraudulent broker.
Advantage 4: Tax benefits. Regardless of how long you’ve held an investment in a commodity pool, you will be taxed on capital gains using the "60/40" rule. Under this rule, 60% of your gains will be taxed at the long-term capital gains rate, which for most investors is lower than the short-term rate. Only 40% will be taxed at the typically higher short-term capital gains rate. This rule is beneficial to commodity traders who prefer to hold on to their investments for less than 12 months. As such, it is great for active commodity traders who usually place trades with short-term and medium-term intents.
Disadvantages of Using Commodity Pools
Disadvantage 1: Risks due to amplified leverage. The commodity market is well-known for the use of leveraged trading. When you invest in a commodity pool, the leverage applicable to the funds being traded is amplified. This might be a great thing to maximize returns, but it also heightens your risks of losses significantly.
Disadvantage 2: Less regulation in the case of smaller pools. Commodity pools exempt from the CFTC regulation might involve fraudulent or brazen operators who promise unrealistic returns or misrepresent their qualifications. Commodity investors need to take extra care when evaluating a small pool that falls outside of the CFTC registration requirements.
Disadvantage 3: The general volatility of the commodities market. This is perhaps not a unique disadvantage of commodity pools compared to other commodity investment options. However, compared to stock market investments, commodity pools are relatively volatile structures simply by virtue of trading commodities — assets well-recognized for their volatility.
Disadvantage 2: Less regulation in the case of smaller pools. Commodity pools exempt from the CFTC regulation might involve fraudulent or brazen operators who promise unrealistic returns or misrepresent their qualifications. Commodity investors need to take extra care when evaluating a small pool that falls outside of the CFTC registration requirements.
Disadvantage 3: The general volatility of the commodities market. This is perhaps not a unique disadvantage of commodity pools compared to other commodity investment options. However, compared to stock market investments, commodity pools are relatively volatile structures simply by virtue of trading commodities — assets well-recognized for their volatility.
Commodity pools, while not without their disadvantages, could be a great choice for commodity traders of all sizes. The ability to leverage the collective power of a pooled investment might be crucial for smaller traders, while still being a useful bonus for larger traders as well. If you are serious about commodity trading, considering these pools should never be off the table.