QYLD - JEPI: The Volatility-Loving Cash Cow

Summary

• JPMorgan Equity Premium Income ETF has been benefiting from increased volatility as option premiums rose.
• JEPI is overweight defensive sectors, which should be more resilient to a recession.
• The Fund has beaten its benchmark since inception, while achieving lower volatility.
• With an 11.3% dividend yield and expense ratio of only 0.35%, JPMorgan Equity Premium Income ETF is a serious candidate for income investors’ portfolios.

The JPMorgan Equity Premium Income ETF ( JEPI ) has made the headlines by entering the top 10 exchange-traded funds ("ETFs") in terms of inflows in 2022 by adding US$12.5B to its assets under management ("AUM"). And there’s a good reason for that. The fund has been benchmarked to the S&P500 (SP500) and aims to capture the majority of its returns, with much lower volatility. JEPI sells covered calls, which is a pretty lucrative business in high volatility environment, allowing it to generate recurring income and distribute substantial dividends to its shareholders. Overall, JEPI seems like a low-cost recession-resilient instrument that should be considered by every income-oriented investor.

Introduction to JEPI

The JPMorgan Equity Premium Income ETF was launched in May 2020, amidst serious economic and market turmoil as whole sectors of the economy were closed down. JEPI’s prospectus , which latest update dates from November 2022, states that the goal of the fund is income generation, while maintaining capital appreciation prospects. As an investment adviser, J.P. Morgan Investment Management seeks to achieve the goal in the following way :

The Fund seeks to achieve this objective by (1) creating an actively managed portfolio of equity securities comprised significantly of those included in the Fund’s primary benchmark, the Standard & Poor’s 500 Total Return Index (S&P 500 Index) and (2) through equity-linked notes (ELNs), selling call options with exposure to the S&P 500 Index. The resulting Fund is designed to provide investors with performance that captures a majority of the returns associated with the S&P 500 Index, while exposing investors to lower volatility than the S&P 500 Index and also providing incremental income.

The fund has caught investors’ interest, and AUM have been growing rapidly, as only in 2022 inflows of US$12.5B were recorded. This sent JEPI amongst the top 10 ETFs in terms of inflows in 2022. This allows JEPI to maintain a low-cost structure with an expense ratio of just 0.35%. The TTM dividend yield that the investment vehicle offers is around 11.3%. So, how is JEPI really structured and how will it performs its stated objectives? In order to find that out, I’m going to examine the fund’s holdings and performance relative to the stated benchmark.

Holdings breakdown

Looking at the sector exposure of JEPI, compared to that of its benchmark – the S&P 500, represented by the SPDR S&P 500 Trust ETF ( SPY ) - it’s evident that the fund’s advisor has underweighted more volatile sectors like Technology and Consumer Cyclicals, while overweighted Consumer Defensive, Industrials and Financials, implying a value tilt. Looking at actual volatility in comparison to the benchmark, it appears that JEPI is doing a great job, as it has achieved much more stable prices since its inception.

Recent performance and prospects

In order to assess JEPI’s performance better, I’ll compare it not only to the benchmark, represented by SPY, but also to three other ETFs, which are generating income through writing covered calls – the Global X NASDAQ 100 Covered Call ETF ( QYLD ), the Global X Russell 2000 Covered Call ETF ( RYLD ), and the Global X S&P 500 Covered Call ETF ( XYLD ).

It turns out that JEPI has been overachieving its mandate, which states that the fund aims to capture “the majority” of SP500 returns, as it has outperformed the benchmark. The other covered call ETFs have been outperformed as well. I think that JEPI’s management, due to its serious experience and expertise, has been able to exploit the current high-volatility environment through increased option premiums, while the value tilt has preserved capital more so than the competition and the benchmark. As market turmoil and heightened volatility are expected to spill into 2023, JEPI should continue to deliver strong yield to its investors.

Risks

The main risk towards JPMorgan Equity Premium Income ETF’s business model would be a decrease in volatility and return to growth. While I don’t expect this to happen in H1’23, the looming recession may force the FED to cut rates towards the end of 2023. This could make growth attractive again and volatility may begin to calm down. In such an environment, JEPI may not be the optimal instrument, while REITs may be considered as an alternative income source. That being said, in the current environment, JPMorgan Equity Premium Income ETF looks like a great option for the portfolios of income oriented investors.

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