JEPI - JEPI: High Yield But Limited Upside

2023-08-21 09:35:27 ET

Summary

• JPMorgan Equity Premium Income ETF (JEPI) is a popular choice for income investors, offering a high distribution yield of 10.2%.
• JEPI is an actively managed ETF with a low expense ratio of 0.35% and focuses on low beta stocks within the S&P 500.
• The fund generates its high distribution yield through the use of derivatives, such as options, but has limited upside potential.

The JPMorgan Equity Premium Income ETF ( JEPI ), has quickly become one of the most popular income ETF options for investors looking for high-yield investments. The ETF is only three years old, as it was launched during the pandemic back in May 2020.

In 2023, investors have endured a rate hiking cycle that has been pushed down from the Federal Reserve, pushing the Federal Funds rate from 0% to now have a range of 5.25% to 5.50%, a cycle that has been swift and steep. The goal of the Federal Reserve has been to combat high inflation, which peaked around 9% and currently sits at 3.2%, based on the latest CPI reading for the month of July.

A higher Fed Funds rate has increased rates all over the financial sector, from High-Yield Savings Accounts to bond yields as well. This has put some pressure on dividend paying stocks, particularly for those investors strictly focused on income. Why invest in a stock with a 3-4% yield, when you can get a 4-6% yield with little to no risk from a bond or HYSA, is the question investors are asking themselves.

However, JEPI has a lot of bond like qualities to it, which I will explain more in this next section.

JEPI Is A Fan Favorite For Income Investors

The JPMorgan Equity Premium Income ETF is geared more towards income investors, after all, the word "income" is in the name of the ETF. The reason I say this is because of the nature in which the ETF is formed. You cannot expect much in terms of share price gains from this ETF like you can from a regular S&P 500 ETF ( SPY ), which offers a lower yield, but the opportunity for capital gains.

JEPI is an actively managed ETF, which typically comes with a higher expense ratio, which can be considered a fee that is reduced from your value held in JEPI. However, for being an actively managed fund, which just means the portfolio managers are actively buying and selling positions on a regular basis rather than taking a more hands off approach, JEPI has an expense ratio of just 0.35%.

JEPI currently has a high distribution yield of 10.2%, which is hard to beat on the open market, whether you are looking at fixed income or elsewhere. JPMorgan has spun off some sister funds, like the JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) which focuses more on Nasdaq related stocks, but it has an even higher distribution yield of 12.0%. I did an article in the past, titled, " JEPI or JEPQ: A Better ETF To Own For Monthly Income. " comparing the two ETFs.

How do these funds have such high distribution yields?

Great question! The reason I refer to it as a distribution yield and not a dividend yield is the fact that dividends are paid by companies to shareholders, but that is just one piece of the puzzle for JEPI. The ETF owns roughly 140 positions, which do in fact pay dividends, but the large majority of the high distribution the ETF pays out is due to their use of derivatives, such as options.

Here is the strategy when it comes to JEPI:

1. Invest in low beta stocks within the S&P 500
2. Sell call options via Equity Linked Notes, or ELNs

By selling call options, this allows the ETF to earn a premium from those options, but at the same time, it also limits the upside of the ETF, which is why you see the underperformance in terms of share price appreciation. Year-to-date, in a time in which we have seen the S&P 500 ( SPY ) climb nearly 15%, JEPI is up only 0.07%, nearly flat.

JEPI Has Limited Upside

Let me try to explain the limited upside for those of you new to options selling. Selling upside calls means you likely own shares of a particular stock, and for this example we can use Apple ( AAPL ). Shares of AAPL currently trade around $175, but you can sell a call option for a strike price of $185. In doing that, you will collect a premium from the buyer of the option contract. Options have an expiration date to them. If shares of AAPL do not surpass $185 by the expiration date, the option seller, JEPI in this case, will keep their shares of AAPL and they earned the premium that was paid to them. This is how they generate the higher distribution yield.

However, if AAPL shares shoot up to say $200, the option seller's shares of AAPL will earn gains up until the strike price, which is $185, but nothing beyond that as they will have to sell their shares to the option buyer at the $185 strike price.

As such, during a move higher in the broader markets, such as we have seen in 2023, JEPI is going to underperform. On the flip side, you will be earning a nice distribution yield, but as an investor, you need to understand that the yield is all you will really be able to rely on, as the actual price has consistently been falling since the start of 2022.

Volatility has creeped higher in recent weeks, and if that keeps up, an investment like JEPI could prove to be a viable investment for the near-term, as the distribution will outperform the broader markets. However, as we have seen for decades, a stock market does not stay down for long, so long-term, unless income is your only goal, JEPI is likely not a position for you.

Top Holdings Within JEPI

Let's begin by first looking at which sectors JEPI is most invested in by looking at the ETF's sector breakdown:

As you can see, the ETF is actually pretty well diversified with Technology being the top sector, having 17% exposure, followed by Health Care and Industrials. Overall, JEPI has five sectors in which they have double digit exposure.

Now let's take a look at the funds top positions:

Amazon ( AMZN ), Adobe ( ADBE ), and Microsoft ( MSFT ) hold the top three positions within the fund, but when you look across the top 10 positions, you can see they have very little exposure to any single stock with the top position accounting for only 1.68%. In total, the fund has 139 positions, but the managers are trading in and out of positions on a regular basis, so this is subject to change on a flash.

JEPI Is Not An ETF For Me

JEPI can be a solid investment for those just looking for income, especially when the broader market is lower or trading sideways. The yield alone will keep you ahead, but when the broader market is moving higher, like we have seen thus far in 2023, JEPI is going to lag due to the strategy they implore with options.

After all, I sell options on a weekly basis, so I am already emploring that strategy within my own portfolio and doing so while outperforming JEPI quite easily.

JEPI is not for everyone, but it is for some, but it is important to understand the structure and why they have such a high distribution yield, which impacts their upside potential.

Thanks for reading and in the comment section, let me know what your thoughts are on JEPI.

Disclosure: This article is intended to provide information to interested parties. I have no knowledge of your individual goals as an investor, and I ask that you complete your own due diligence before purchasing any stocks mentioned or recommended.

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