JEPI - JEPI: Worth The Yield?

2023-04-22 07:00:00 ET

Summary

• JEPI is a high-income ETF that utilizes an approach of not only owning dividend-paying stocks, but also utilizing a covered call strategy.
• This allows the ETF to pay a double-digit distributions percentage on an annual basis.
• As such, the money earned from both dividends and option premiums is then distributed to shareholders.

One of the most talked about exchange traded funds ("ETF") over the past year plus has been the JPMorgan Equity Premium Income ETF (JEPI). JEPI is an ETF that focuses on high income based on their approach of owning not only dividend stocks, but also utilizing derivatives such as ELN's and covered calls to juice a high distribution yield. Income produced from both dividend payments and premiums are then passed onto the shareholder.

JEPI's Objective

Here's a look at JEPI's objective based on the issuer's website :

JPMorgan Equity Premium Income ETF seeks to deliver monthly distributable income and equity market exposure with less volatility.

The fund is managed by a set of portfolio managers with over 60 years of combined investing experience. The fund utilizes options as a way to generate higher income by writing out of the money S&P 500 call options, which we will discuss in more detail below.

Utilizing Covered Calls

One of the main strategies behind JEPI is the use of Equity Linked Notes ("ELNs") as well as covered calls. For those of you unfamiliar with covered calls, let's take a few minutes to explain.

A covered call is an option contract where the option seller owns the underlying stock or ETF that you're going to sell. Selling a covered call to a third party gives the buyer the right to purchase the underlying security at an agreed upon price (strike price) by an agreed upon date (expiration date). Every option contract has a buyer side and a seller side.

1 option contract = 100 shares of the underlying security, which is often a stock or ETF.

When selling an option, you earn a premium . Selling a covered call means that if the underlying security's price goes above the strike price by expiration, you would be required to sell 100 shares per contract you sold at the strike price. So, in order for this option contract to be considered "covered," you need to own at least 100 shares of the underlying position.

Covered Call Example

Let's use Microsoft ( MSFT )as an example. If you wanted to buy 100 shares of Microsoft today, you would spend $28,505 as the stock price is currently $285.05. If you owned 100-plus shares of MSFT and you believe the stock will stay stagnant or even come under pressure, you may be enticed to sell a covered call to collect a premium. You also may have say 500 shares of the underlying security and want to lower your position to recognize some of those gains, so you sell a covered call.

Let's say you wanted to sell the $295 call option, which you can see in the option chain below, you could earn a premium of $4.75 per contract or $475. When a buyer agrees, you will receive the $475 premium into your account immediately.

If by the expiration date (May 19), shares of MSFT are trading below $295, you keep the $475 as profit and the option contract is considered worthless because the option buyer would be better off buying shares on the market, which is lower than the strike price.

If by the expiration date, shares of MSFT rise above the $295 strike, say to $300, you would be required to sell your shares for $295 to the option buyer. They instantly buy shares at $295 that are worth $300, so a $5 per share gain for them that you the option seller would not partake in.

You can see how this strategy can provide solid income, and it can be done in a less risky way as well. The further out the strike price is from the current price, the safer the option, but that also comes with less premium. In the case of JEPI, they sell what is called "out-of-the-money" call options, meaning the strike price is above the current price, which allows them some upside in the price gains.

When all is said and done, the seller of the call option gets to keep the premium, but if the stock is trading above the strike price, the seller forfeits any gain past that level.

This only scratches the surface with options, but this is a high-level explanation of covered calls, which is a popular option strategy to start with once you amass at least 100 shares. This strategy also provides some safety in the case the stock drops.

JEPI Top Holdings

As mentioned at the open, JEPI also invests in dividend stocks. Overall, JEPI has 131 total positions. Here's a look at the top 10 positions and their weighting within the fund.

A Closer Look At The Top 5 Holdings

AbbVie ( ABBV )

AbbVie is the new top position within JEPI. The company had the top selling drug in the world in Humira for a number of years. But in 2023, the patent expired on the drug and generics are expected to flood the market over the next few months. ABBV has a market cap of $281 billion. ABBV pays a dividend yield of 3.7% with a five-year dividend growth rate of 14.5%. ABBV has a forward P/E ratio of 14.5x compared to a five-year average earnings multiple of 10.8x.

The Progressive Corporation ( PGR )

Progressive Corp has a market cap of $81 billion. PGR pays a dividend yield of 0.29% and has a Forward P/E ratio of 24.6x compared to a five-year average earnings multiple of 18.4x.

The Hershey Company ( HSY )

The Hershey Co as a market cap of $53 billion. HSY pays a dividend yield of 1.6% and has a Forward P/E of 29.5x compared with the five-year average P/E of 25.5x.

Mastercard Incorporated ( MA )

Mastercard operates within the Financial Services sector and has a total market cap of $355 billion. MA pays a dividend yield of 0.61% and has a Forward P/E of 30.4x with a five-year average multiple of 37.9x.

The Coca-Cola Company ( KO )

Coca-Cola Co is a multinational beverage corporation with a total market cap of $275 billion. KO pays a dividend yield of 2.9% and has a Forward P/E of 24.5x compared to a five-year average earnings multiple of 25.8x.

JEPI's High Distribution

The main thing that attracts investors to JEPI is the high distribution yield. During the past 12 months, JEPI investors have earned a distribution yield of 11.31%. These distributions are paid out on a monthly basis, which is another thing that attracts investors seeking higher income. These distributions vary from month to month due in part to the strategy they employ.

When you see ETFs with high distribution yields, especially actively managed funds like JEPI, they tend to have a high expense ratio pinned to them. In JEPI's case, they have an expense ratio of 0.35%, which is actually not all that bad for an actively managed fund. Often you will see actively managed funds with expense ratios well above 0.75%.

In terms of performance, JEPI will tend to lag the greater market during strong bull markets, but fare much better during market stagnation or downturns, as their high distribution helps offset falling stock prices. Over the past three years, JEPI has slightly underperformed the S&P 500 in terms of total return.

Investor Takeaway

When it comes to JEPI, you need to know what you are investing in. Far too often investors will look at a high yield and see monthly dividends and instantly be attracted. However, you need to dive deeper and understand the investment to the fullest extent.

With JEPI, yes the income is nice, especially in 2022 when the greater S&P 500 fell into a bear market. However, when the market turns around, and investment like JEPI is going to lag due in large part to the strategy it uses with the utilization of ELN's and covered calls.

So, if income was the only thing you were after, JEPI can be a valid investment, but for those of you with a longer time horizon focused more on total return, JEPI may not be the answer.

Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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