JEPI - JEPI: Is This Massive 11% Yield A Buy?

Summary

• JPMorgan Equity Premium Income ETF is a high-yielding ETF with low volatility.
• That makes JEPI attractive for income investors looking for a stable pick.
• There's a downside to JEPI's strategy, however.

Article Thesis

JPMorgan Equity Premium Income ETF ( JEPI ) is an income-generation-focused ETF that offers a hefty dividend yield of more than 11% at current prices. Retirees and other income investors thus could be very interested in this fund. However, investors should note the downside of this yield-focused strategy, which is the limited upside during times when the broad market is climbing. Still, for some investors, JEPI could be a very solid pick.

How Does JEPI Work?

JPMorgan Equity Premium Income ETF has a somewhat complicated strategy. Unlike simple ETFs such as SPY ( SPY ) that solely replicate an index, JPMorgan Equity Premium Income ETF operates with a different approach. JEPI combines a portfolio of low-volatility equities that oftentimes offer solid income yields. The ETF's top holdings include the following companies:

Companies such as AbbVie ( ABBV ), Bristol-Myers Squibb ( BMY ), Coca-Cola ( KO ), and Exxon Mobil ( XOM ) offer above-average income yields in the 3% to 5% range. None of these companies have a weight of 2% or more in the ETF, thus the equity portion of the ETF's holdings is well-diversified. Even if one of these companies were to run into problems and a dividend cut occurs, that would not impact the overall ETF's income generation potential meaningfully. Thanks to these stocks' high income yields, they are generally suitable for an income-focused ETF such as JEPI. Of course, the ETF's yield is much higher than the yield of its top equity holdings, which is why JEPI has to generate additional income in other ways to be able to pay a dividend yield of more than 11%.

JEPI does this by also utilizing options to generate income. Writing (= selling) calls results in additional proceeds via the option premium that JEPI receives. These option premiums that JEPI receives via call writing are what allow JEPI to pay a dividend yield that is way higher than the dividend yields that its core equity holdings offer.

This approach is way more complicated relative to a pure and simple index-replicating strategy that many ETFs pursue. That, of course, also makes JEPI more costly -- its expense ratio of 0.35% is around three times as high as that of many index-replicating ETFs. But due to the active management -- the managers of the ETF have to analyze and decide which equities to buy, for example -- these higher expenses aren't simply a tool to boost profitability. Instead, they seem justified due to the additional work for the ETF manager. Relative to some other actively managed ETFs, such as ARK Innovation ( ARKK ), the 0.35% expense ratio also isn't high -- ARKK's is around twice as high, for example.

The stocks that JEPI owns have some noteworthy characteristics:

First, the valuation is at an above-average level, relative to how the S&P 500 index is valued today. This is mainly due to the high valuations for some of the low-volatility consumer staples companies that JEPI owns, such as Coca-Cola or PepsiCo ( PEP ), which are valued at more than 20x net profits.

The weighted average market capitalization is less than half as high as that of the broad market index, which can be explained by JEPI's underweighting of tech mega-caps such as Apple ( AAPL ), Microsoft ( MSFT ), or Amazon ( AMZN ). Instead, JEPI primarily owns large, but not ultra-large companies such as the aforementioned AbbVie, Coca-Cola, and so on.

The volatility of investments is generally measured via a metric called "beta". Beta measures a stock's volatility versus that of the broad market. The portfolio that JEPI owns has an average 1-year beta of 0.66. That means that for every 1% move in the broad market, JEPI's equity portfolio moves by 0.66%, on average. A 20% decline in the broad market would thus translate into a 13% decline for JEPI. That fits very well with management's goal of providing substantial returns with less volatility, as stated in JEPI's fact sheet:

Seeks to deliver a significant portion of the returns associated with the S&P 500 Index with less volatility, in addition to monthly income.

The low volatility is also showcased by JEPI's below-average standard deviation, which, at 16%, is around one-third lower than that of the broad market. These factors make JEPI a compelling pick for investors seeking a low-volatility investment that will not go down too much during a market downturn or market panic. JEPI has the potential to improve the stability and resilience of a portfolio thanks to these characteristics.

The low volatility of JEPI's equities and the strategy of selling calls in order to increase income for investors has a downside, however, that shouldn't be ignored by investors.

Upside Is Capped

JEPI is a resilient and high-yielding investment, but the strategy and the composition of its equity portfolio mean that JEPI will likely underperform in a market rally. The beta of 0.66 of JEPI's equity portfolio means that JEPI will move down less than the broad market in a market pullback. But at the same time, in case markets rally, JEPI's equity portfolio will likely underperform as well. The underweighting of volatile tech stocks would likely mean that JEPI would not climb by 20% in case the broad market jumps up by such an amount, which might happen in case the Fed pivots, for example.

On top of that, selling covered calls caps the upside even further. When you sell a covered call, there is a limit to your potential gain, whereas simple equity investments without the selling of a covered call have theoretically unlimited upside potential. Investors that buy into JEPI do thus not get the massive income yield and the low volatility for free -- instead, they pay for that by potentially foregoing some future gains. That can be a well-thought-out trade for some investors, depending on one's personal investment goals. But it likely isn't the correct choice for everyone -- more aggressive investors will likely prefer the unlimited upside that one benefits from when investing in an ETF like SPY.

Strong Income Generation

Right now, JEPI pays out $0.61 per month, based on the most recent dividend payment. That pencils out to around $7.30 per year, which translates into a dividend yield of 13.3% -- which is massive. Not every monthly dividend payment is this high, however. Over the last year, JEPI has paid out $6.26 per share, which pencils out to a little over $0.50 per month. That translates into a dividend yield of 11.4%. That's not quite as strong as the yield when we annualize the most recent payout, but an 11%+ dividend yield is still great, of course.

Due to the ups and downs in the proceeds from call writing, investors have to live with some volatility when it comes to overall dividend payments from JEPI -- some months will be better than others, and that will always be the case.

Overall, dividends have been trending up. In 2020, JEPI paid out $3.23 per share, while dividends in 2021 totaled $4.16. This year, JEPI will pay out more than $6.00, which is a huge improvement over 2021. Increased market volatility plays a role in that, as it allows call sellers to capture higher premiums, all else equal. When markets calm down and volatility declines, option premiums will likely be lower again, which could translate into lower dividend payments. While the dividend trend has been upward, investors might have to live with lower dividend payments at some point in the future. The good news is that a dividend reduction towards $4 or $5 per share would still allow for a pretty nice dividend yield in the high single digits -- and it's not at all guaranteed that there will be a dividend reduction, it's just a possibility.

Takeaway

JPMorgan Equity Premium Income ETF looks like a compelling choice for income investors seeking a low-volatility investment. JEPI will, due to its low beta, likely outperform during market declines (including the one we are experiencing right now) and offers a hefty income yield that is paid out monthly.

On the other hand, the upside in a bullish scenario is more limited relative to an ETF like QQQ due to the composition in the equity portfolio and due to the call writing the ETF does, thus JEPI is not for everyone.

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