ICAP - ICAP: Round 2 Goes To JEPI In This Covered Call Battle

2023-10-10 10:00:00 ET

Summary

• InfraCap Equity Income Fund ETF and JPMorgan Equity Premium Income ETF have struggled to provide meaningful total returns over the past 4 months.
• But JEPI has outperformed ICAP by a significant margin, with a 5.28% differential in returns.
• We examine what worked for JEPI vs ICAP and why we still continue to favor it.

Absolute value is often hard to determine for funds. Relative valuation is far easier to assess. So if you asked in June of this year whether InfraCap Equity Income Fund ETF (ICAP) and JPMorgan Equity Premium Income ETF (JEPI) would deliver positive returns over the next 4 months, we would have gone with "No clue". But if you wanted to know which would likely give you better returns, we could pick a winner. If you wanted to know which could give you the best risk-adjusted returns, we would have a table pounding answer for you. We did give you just that and you did not even have to read the whole article to find out.

4 months have passed and we have to see our report card. Let's look at how that played out and how we see this battle going forward.

The Funds

We have introduced these funds in more detail previously, so investors will need to read that if they need a refresher. There was a lot of effort into comparing JEPI with Nationwide Nasdaq-100® Risk-Managed Income ETF ( NUSI ) as well and those articles (see here and here ) are also excellent background reading material for option-income funds. Here, we will focus on the aspects relevant to the performance of ICAP and JEPI over the past few months and going forward.

Performance

Over the last 4 months (since our last article), ICAP and JEPI have struggled to provide meaningful total returns. But there has been one clear winner here.

A 5.28% differential is well past 15% annualized and that is quite a bit of alpha if you chose JEPI over ICAP. On a price basis, the differential is similar as both are distributing similar levels of income.

What Happened?

The current sector weights for the S&P 500 are shown below.

ICAP has been massively overweight 4 sectors relative to the S&P 500 ETF ( SPY ).

Financials have performed about in line with S&P 500 ( SPY ) while energy has done spectacularly well. So no points deducted there for ICAP. But real estate and utilities have absolutely been crushed.

The net result from that has been a sector selection which created a big drag. Even with REITs, ICAP previously had heavy exposure to mortgage REITs with, Annaly Capital Management Inc. ( NLY ), AGNC Investment Corp. ( AGNC ), Rithm Capital Corp ( RITM ) and Chimera Investment Corp ( CIM ) forming over 9% of total fund exposure. We see in the latest holdings report that this has been whittled down a bit, which reduces future risk.

On the JEPI side, the fund continued its methodical stock selection and did not overweight any sector by a lot. Sure there was a switch between the percentages for Consumer Staples and Discretionary versus the S&P 500, but that did not hurt the fund.

The big underweight for JEPI as usual was information technology and it appears the managers (much to their credit) refuse to drink AI Kool-Aid. That rational decision did hurt them once again as technology outperformed.

Outlook & Verdict

Leverage. We just don't want it at this stage of the cycle and that is the key point we want to weigh in when we consider ICAP against JEPI. Covered calls reduce your beta and leverage adds it right back. Don't believe us? Well here are the funds proudly strutting their 1 year Betas. Which do you want to help you sleep at night?

It is hard work trying to make all of the covered call complexity and large monthly distributions work with leverage. Investors might argue that professionals can do it. Perhaps. But here are ICAP's results since inception. That again is a total return including those large distributions.

You might be tempted to give extra credit for ICAP backing its picks and sector allocations. That is a fair point and we might give this experiment more time, if it did not have leverage. So far, the NAV is down about 30% since inception. Yeah the income crowd probably has the urge to chime in that the distribution run-rate has basically been maintained. The response is that JEPI has created a similar income stream while being far more NAV friendly.

Going into year-end, we think value will outperform growth as we are seeing some extremes in price movements between the two. This should help both funds though ICAP may get a little more juice from its leverage. Some might find it surprising that JEPI would get mileage out of this but its individual stock selection coupled with index options are a pseudo "Long-Value-Short-Growth" play. So ICAP could outperform into year-end. Beyond that, we would strongly consider reallocating away from ICAP as the fund is a relatively poor choice for covered call income. JEPI is one that gets our vote.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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