SVOL - JEPQ: Equity Premium Still Not Attractive Over Alternatives

2023-11-14 00:35:42 ET

Summary

• JPMorgan Nasdaq Equity Premium Income ETF claims to offer current income, volatility management, and exposure to the Nasdaq 100 index.
• The fund aims to deliver both capital appreciation and current income, with a whopping 11.76% yield and volatility lower than the index.
• JEPQ's underperformance in total return, volatility, and income distributions compared to alternative strategies make it a sub-par choice for income portfolios.
• JEPQ is at the top of the pack of options-themed ETFs for good reason but is still not strong enough for inclusion in a modern income portfolio.

Introduction

Venture anywhere in online investing message boards, and you'll inevitably run across folks talking about JEPQ , the JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) and its older, much larger sister fund, the JPMorgan Equity Premium Income ETF ( JEPI ) (or ( JEPIX ) for my fellow mutual fund snobs). These ETFs offer equity exposure and consistent income, by writing options against portfolios of large-cap stocks. JEPI focuses on dividend-yielding S&P 500 stocks while the focus of our article today, JEPQ, holds a portfolio of 83 stocks that closely represents the Nasdaq 100 ( NDX ) while being screened for quality by the managers.

With these new, options-driven ETFs, investors are given a sales pitch of "growth and income."

It's often a choice investors must make, either investing in growth stocks that offer low dividends, or value stocks that may have stagnant price growth but pay higher dividends and provide income. JEPQ seeks to offer investors access to "both worlds" so to speak, capital appreciation and current income by using the options overlay to supplement the dividend payments.

As much as it feels natural to start saying, "if it sounds too good to be true," let's look at the data. How has it done? Below, Figure 2, is the total return against its benchmark's ETF, QQQ . Figure 3 shows the performance in a scenario with DRIP, where all distributions and dividends are re-invested back into shares at the moment of distributions.

JEPQ underperforms in both back tests, unfortunately. It does, however, perform well in other categories. For example, JEPQ has a lower standard deviation (18% vs. 25%).

There is not too much to be impressed with so far, especially if investors have held this in a taxable account, as the ordinary dividends from JEPQ may have higher tax burdens than capital gains from equivalent sales of QQQ stock for the same income every month. This is especially true for investors who have held their shares of QQQ long enough to have long-term capital gains taxes apply.

With total return out of the way, let's analyze how well the fund has met its various objectives.

JPMorgan describes the fund's objectives as:

Generates income through a combination of selling options and investing in U.S. large cap growth stocks, seeking to deliver a monthly income stream from associated option premiums and stock dividends

Seeks to deliver a significant portion of the returns associated with the Nasdaq 100 Index with less volatility

Constructs a long equity portfolio through a proprietary data science driven investment approach designed to drive portfolio allocations while maximizing risk-adjusted expected returns

Let's break each of these down to see if JEPQ's managers have been able to deliver on these objectives.

Note that this is not going to be an analysis of JEPQ's holdings. That is better left to an article on QQQ. Instead, I am going to analyze the strategy behind JEPQ and evaluate if it should be held in place of QQQ.

Income

The first objective is current income. JEPQ delivers a whopping 11.76% yield, on par with (and at the high end of) CEFs and similar funds that seek to deliver current income.

JEPQ's dividend has been fairly consistent. We should expect this consistency to continue moving forward, with months varying, but the managers have shown their ability to hold their target yield of around 10%.

Last month, I covered SVOL , a fund designed to sell equity volatility in a more direct way. Please take a look at that article and Simplify's explanation of how SVOL captures equity premium with its VIX carry strategy if you'd like to learn more about it before continuing.

I really encourage folks who are interested to read through those links before continuing. I believe that SVOL is a better replacement for all equity income funds, but it is important that you understand all products you intend to invest in.

SVOL takes JEPQ's idea of selling volatility for income and isolates it, providing investors a source of income but without the equity exposure JEPQ aims to capture.

VIX carry provides a higher and more stable income, as well as similar overall returns.

This is particularly interesting as stocks have ripped this year, with NDX up significantly YTD. Since inception, you can see the back-and-forth played by NDX and JEPQ. What's exciting is when you overlay SVOL atop it, and you can see the equity risk apparent in volatility in both JEPQ and QQQ, where there is no short-options overlay to reduce equity exposure.

It is to note that when just looking at portfolio income on a real portfolio backtest with DRIP, from JEPQ's inception till now, it does impress compared to little old QQQ.

There are other strategies in the options and alternatives space that are offering monthly income and high yields, basing their equity exposure on NDX. Let's take a look at the category and see how JEPQ has stood up against its competition.

As far as the income goal of the fund is concerned, JEPQ is not the best choice for investors. We can see that over JEPQ's lifetime, VIX carry (short options risk premia) has outperformed as a standalone strategy at providing income and for total return. This may not always be the case, but should give us pause when considering JEPQ for its exposure to this strategy.

JEPQ's other objectives get in the way of its ability to generate consistent income through short index options. It is neither better at being a core equity holding than QQQ, nor is it better at extracting volatility income than SVOL.

Let's see how it fares on the other objectives.

P.S. Shame on Nationwide and Nuveen's funds for their negative total returns in a timeframe where the index is up 16%.

Volatility

There is something to be said about a fund that offers lower volatility. This can be helpful in handling the hardest part of investing for most folks: psychology. A lowered volatility, greater risk/reward ratio, and fewer, less severe drawdowns can save investors from making costly mistakes if they overestimate their true risk tolerance. Lowered volatility may also be useful in investing strategies involving asset allocation.

If JEPQ can offer that lowered volatility, it may potentially fill a job that some investors find valuable. I'm not one of these people, but I've read this sentiment across comments sections and message boards, so I've decided to include this as a pro for lowered volatility.

JEPQ does offer lower volatility overall. We can look at it in several ways. In the portfolio test we did earlier where I accounted for DRIP, JEPQ had a standard deviation of 18.03% while QQQ's was 24.91%.

Rolling volatility shows us just how much volatility can have periods of high and low correlation with beta. Note that I'm using QQQ here, since I cannot get this same data for NDX directly.

There is more to volatility than just standard deviation numbers. Here is how these funds have compared in other meaningful metrics.

This table was made using DRIP and with a backtest from JEPQ's inception. I use 6/1/22 as a start date.

Overall, these metrics are a reflection of JEPQ's persistent issue with equity exposure. The long drawdown periods coincide with QQQ's and the max drawdown being less is still good for JEPQ, but the fund still has equity levels of loss and drawdown. JEPQ's volatility isn't managed enough to say that it has any real downside protection to offer that other funds specifically designed for downside protection like ( BTAL ), ( CYA ), or ( TAIL ) couldn't offer in a better or more direct way. They may not provide "income" in the same way, but they are certainly going to be better at managing volatility.

A miss on 2/3 so far. Let's see if JEPQ can pull it together with its last objective.

Equity

This is in fact where I get to say that JEPQ's equity exposure is strong. I am a fan of JPMorgan's management, typically. Here are the primary differences between JEPQ and QQQ's holdings.

Their top 10 are very similar. Notice JEPQ's reduced concentration in top names. It holds fewer stocks, but has more diverse equity exposure than QQQ.

I prefer diverse exposure in equities, and so I will call this a win for JEPQ here. There are also a few tweaks across sectors.

JEPQ has lower exposure across the board to allow for exposure to financials, a sector that QQQ purposefully excludes .

Without going into the bull or bear cases for QQQ itself (again, an article best left for the QQQ ticker and as a standalone piece), I believe the inclusion of financials and the trimming of a small amount of P/E, P/B, and P/S of the total portfolio is a good thing for the index and could provide some excess returns in the form of the value premium.

This aspect of JEPQ gets an approval from me, but that wasn't necessarily surprising. I'm vocally not a fan of QQQ for its odd inclusion criteria, but its dominance in investing has made it a topic of constant interest. Having a "fixed" version of the index, excluding a few names and including others, dreamt up by the JPM team, sounds like a better alternative.

If it weren't for that darn options overlay not performing up to snuff.

Conclusion

The JPMorgan Nasdaq 100 Premium Income ETF offers investors the "best of both worlds" with its promise of price appreciation and monthly income. While it achieves these goals to varying degrees, there appears to be better alternatives on the market that have offered better outcomes for investors.

For income, SVOL shows us that we have a better way to extract equity premium that doesn't provide for the same beta or downside exposure while giving us a higher and more stable income.

When it comes to volatility management, call options are not very protective and the income offsetting capital losses did not save JEPQ's total return from underperforming both premium income ( SVOL ) and its non-overlayed benchmark, NDX.

It is to be noted that JEPQ did outperform its peers in the options-equity ETF space.

JEPQ suffers from the "jack of all trades, master of none," syndrome. There are better alternatives for investors in all the individual objectives of the portfolio.

You can come up with some strange backtests playing around with allocations. I chose 70/30 since JEPQ has a natural ~0.7 to QQQ.

Is there an ideal asset allocation strategy where JEPQ is preferable to either QQQ, SVOL, or a combination of these funds? Please leave a comment with your rationale.

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