JEPQ - JEPI Or JEPQ: A Better ETF To Own For Monthly Income

2023-06-15 10:35:00 ET

Summary

• Income ETFs have become very popular of late with new funds hitting the market regularly.
• JEPI paved the way and has been one of the most popular income-focused ETFs but JEPQ is the newcomer.
• Both ETFs have similar strategies, but how those strategies are implemented is very different.

When it comes to Income ETFs, the most popular has to be the JPMorgan Equity Premium Income ETF ( JEPI ) which has hit the ground running in May 2020 when the fund was launched.

Since the launch of JEPI, we have seen a number of other income focused ETFs hit the market due to the JEPI's popularity. One of those income focused ETF is a sister fund, also launched by JPMorgan. That fund is the JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ).

The two ETFs have a lot of similarities, which we will detail out in today's article, but how those strategies are implemented are different for the two funds.

Do You Prefer JEPI or JEPQ?

JPMorgan Equity Premium Income ETF ((JEPI))

As I stated a second ago, JEPI is an income focused ETF, after all it has 'Income" in its title. The fund was launched in May 2020 and has gained a lot of notoriety from income investors.

The ETF is less focused on share price appreciation, although they like that, but the top priority is generating high amounts of income.

JEPI has a very high distribution yield above 11%, but over the past 12 months, you can see that the share price is actually down 4%.

JEPI is an actively managed ETF, meaning the portfolio managers buy and sell in and out of positions on a regular basis. Actively managed ETFs tend to have high expense ratios tied to them, but that is not necessarily the case for JEPI. JEPI has an expense ratio of 0.35%, which is not terrible by any means for being an actively managed ETF.

So how might JEPI generate such a high distribution yield you might ask.

As a dividend investor, you are aware that the dividend yield has an inverse relationship to the share price. As a share price goes up, a dividend yield goes down and vice versa. Well we just saw JEPI's share price has been relatively flat over the past 12 months and yet they have a double digit distribution yield.

Here is how JEPI is constructed to pay such a large distribution. The managers take a two pronged approach:

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

Dividends from the equities they own combined with the option premium they earn is what makes up the income they pay out to investors. The majority of the distribution comes from the option premiums they earn as the equities they invest in do not necessarily need to be dividend paying stocks.

Let's have a look at the top 10 holdings within the JEPI portfolio:

The top position is actually Adobe ( ADBE ), but as you can see the exposure rate is pretty low across the board with all 10 positions every close to one another. In total, JEPI has 138 total positions and the top 10 positions make up only 15% of the entire fund.

When it comes to selecting positions within the portfolio, the managers focus more on low beta stocks, which tend to be more mature companies that are less volatile. The turnover ratio is high, which means there is a lot of trading in and out of the fund.

In terms of sector exposure, here is a breakdown based on the holdings within the ETF:

So now that we understand that JEPI owns both stocks and sells call options for premium, let's look at the ETFs TOTAL return now over the past 12 months, since that will tell a more complete picture.

The share price has fallen 4% as we saw earlier, but when you include the distribution, the ETF has a 12-month total return of nearly 9% and over the past three years, essentially since JEPIs inception, the ETF has gone toe to toe with the S&P 500 with a total return of 41%

One last thing to mention before turning our attention to JEPQ, and something a lot of investors really like about JEPI is not only the high distribution yield above 11%, but that the fund pays out its distribution every month. Now given the nature of the ETF, the payout will not be consistent in any month, so it will fluctuate based on performance of the call writing strategy.

JPMorgan Nasdaq Equity Premium Income ETF ((JEPQ))

JEPQ is the little sibling to JEPI having been founded just a year ago in May 2022. The idea behind the ETF is exactly the same in terms of generating income for investors and looking for some capital appreciation, but although the strategies are similar, the approach is different.

Looking here you can see the investment process when it comes to JEPQ. JPMorgan utilizes 40+ years of data to select high-quality Nasdaq-related stocks and then they sell 1-month out of the money call options to generate income.

If you are unfamiliar with selling call options, you are essentially selling the option for the buyer to purchase the underlying stock at an agreed upon strike price. Every option contract has an expiration date. If the underlying security does not reach the strike price, the option seller, JEPQ in this example, keeps the premium as 100% gain. If the underlying stock rises above the strike, they must sell that stock at the strike price, so the upside has a cap.

By doing this, similar to JEPI, the fund receives large amounts of premium, which helps them pay such a large distribution. The distribution yield for JEPQ is currently 11.9%, even HIGHER than that of JEPI. The distribution is also paid out on a monthly basis.

As you can see on this chart, JEPQ, in terms of share price, is roughly flat over the past year.

The ETF also comes with an expense ratio of 0.35%, the same as JEPI.

JEPQ takes the same approach in terms of selling options and owning securities. However, unlike JEPI, low beta is not a focus for JEPQ and instead, these portfolio managers are focused more on Nasdaq, technology based stocks. Looking at the top 10 holdings and sector breakdown below, you will see JEPQ has much more exposure to the top holdings and the technology sector whereas JEPI was more diversified.

JEPQ has only 87 total positions within the fund and the top 10 positions make up 56% of the entire fund.

In terms of sector exposure, here is a breakdown based on the holdings within the ETF:

Now let’s look at how JEPQ has performed in terms of total return over the past 12-months, which is essentially the life of the fund.

JEPQ has a total return of 15.3%, far exceeding that of JEPI, which makes sense given that Technology has largely pushed the market higher for much of that period on its own.

Pros & Cons of Both ETFs

When it comes to income focused ETFs like JEPI and JEPQ, they are not for all investors. The income is nice, but the capital appreciation can be muted and wither away over time, which is a risk with these types of ETFs.

In addition, during a bull market, when you invest in an ETF that utilizes selling call options, there is limited upside. As I explained above, when a share price jumps above a strike price, the option seller's gain is capped at the strike price and then they are required to sell shares at a lower price than the new market rate.

On the flip side, when share prices are stagnant or falling, the capital amount will fall, but the ETF will be able to generate high amounts of premium income to help offset any equity losses.

Understanding the true nature of these ETFs, knowing that investors take a position in either of these primarily for the income and not for much in terms of capital appreciation. Retired investors living off their dividend income can find the likes of JEPI and JEPQ quite useful.

I like the actual positions that both JEPI and JEPQ invest in, whereas there are some income focused ETFs that focus more on the option selling, without having the stocks to fall back on.

So which is the better buy?

Determining which of these ETFs is the better buy really comes down to preference.

• The expense fees are the same
• The capital appreciation is roughly the same
• The distribution yields are not too far apart
• The strategies are roughly the same

The real difference comes down to how the strategies are implemented. JEPI focuses more on taking a diversified approach and investing in low beta stocks. JEPQ on the other hand is more top heavy in terms of top 10 positions and the technology sector overall.

I do not think there is any RIGHT or WRONG answer but it is important to understand how both ETFs operate before investing.

Moving forward, there are some concerns with JEPQ given how overvalued many analysts believe big technology names are at the moment. This could add pressure to the actual holdings of the ETF.

Based on the elevated valuations both in the technology sector and the S&P 500 overall, I believe there could be some near-term pressure for the market, as such, I would rate both of these ETFs a hold at the moment.

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