JEPI - JEPQ Vs. JEPI: 3 Factors That Sway Our Opinion

2023-03-28 06:00:00 ET

Summary

• We have covered JEPI several times in the past and favored it over NUSI.
• We now look at a newer offering from JPMorgan, i.e. JEPQ.
• We describe our earlier views on JEPI and use that as a springboard to tell you why we favor one of these over the other.

We have covered JPMorgan Equity Premium Income ETF ( JEPI ) a number of times on this platform. Priced at a competitive 0.35% (annual expense ratio), and with yield close to 10% or at times even higher, it is quite popular with legions of income investors. JEPI earns this yield using a two pronged approach. It invests in low beta equities trading in its primary benchmark, the S&P 500 index and it sells call options on the index via Equity Linked Notes or ELNs. Dividends from the equities and option premiums are drivers of the monthly distribution to its investors. The equities chosen need not necessarily have to be dividend payers. The option premiums are a bigger contributor to the distributions. The ETF came into being in May 2020 and enjoyed an extended honeymoon period for over a year. The volatility trend has not been its friend since then, but it has managed to maintain its peak total returns level until now.

We have almost always covered JEPI as a comparison with another ETF that employs option strategies, the Nationwide Risk-Managed Income ETF (NYSEARCA: NUSI ). The latter's income earning strategy is comprised of selling calls and buying puts i.e. collar strategy on the Nasdaq-100. The aim is that the premiums from the calls fund the put purchases and the excess serves as income to be distributed to its investors. NUSI more or less keeps up with JEPI in the distribution yield department. While we own neither, JEPI has trumped NUSI in our write ups almost every time. In June 2022, our most recent piece, we updated our thesis to note that both of the ETFs were on a level playing field for the next few months. We said:

A Short NUSI, Long JEPI strategy provided fantastic alpha. Those that were long NUSI and switched to JEPI also avoided a lot of pain. At this time, we are ending the trade and think there is room for both horses to perform equally well over the next few months. Once the smoke of these oversold conditions has cleared and we observe the deployment of collars over the next few months, we will update whether we want to get into this trade once more. For now, we are upgrading NUSI to a Neutral/Hold Rating from the Sell we had it at. We are maintaining JEPI at a Neutral/Hold rating.

Source: JEPI Vs. NUSI: And The Winner By A Knockout

While JEPI has absolutely demolished NUSI since its inception in 2020, we can see that both have sort of stalled since our call mid last year.

Instead of doing another JEPI vs. NUSI comparison, today, we will talk about another option based ETF from the house of JP, the JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ). As indicated by its name, this one uses the Nasdaq-100 index as its primary benchmark. Its investment strategy is similar to most covered call funds, that is, earn dividends from a portfolio of equities primarily from the index, and sell call options via ELNs. Dividends and call premiums power the distributions.

Introduced in May 2022, this one is less than a year old and has the same annualized expense ratio as JEPI, i.e. 0.35%. It has underperformed JEPI during this time frame, but not by an earth shattering amount.

JEPI came in an era of unprecedented euphoria in the market and has the added goodwill borne from its 2020-mid 2021 returns. However, even taking it as a standalone ETF, JEPQ has not had a good start to the year vis-a-vis its benchmark index.

Notable here is the underperformance in a flat market. On the three month timeframe, JEPQ delivered negative 0.87% versus a positive 0.33% for the NASDAQ 100. That gets us to our first point. There is no "free money" and if selling options was the easy way to make extra, everybody would do it, all the time. Monthly options create massive whipsaws where you get poor extra returns for often losing huge upside. That event is followed by closing out the same options at a higher price, i.e. a loss. This is also where a methodical process of thinking when to sell options, and when to pass on it, can add alpha. Funds dedicated to using options to provide income, generally cannot put a pause to this option selling.

The second point is that even when you do get outperformance in down markets, it is not enough and seldom worth it. So far we have not even got any outperformance in the negative timeframe, but you can see in the August 2022 to October 2022 period, the outperformance was very modest.

The fund sends you large amounts of income and that means that NAV depletion is huge when this happens. That NAV depletion means that the fund has a harder time generating the original income level at identical levels of VIX (or rather VXN which is the NASDAQ volatility index).

Verdict & Comparison To JEPI

Despite being latched on to a stronger underlying index, NUSI never won against JEPI in all our coverage. In their case, it came out to JEPI's option strategy trumping NUSI's and we laid it out for our readers with data using data from CBOE. In our current case, both JEPI and JEPQ employ the similar (though not identical) options strategy and with different benchmarks. So what it comes down to is to three things.

First, our outlook for the respective indices. While NASDAQ had been the stronger of the two from 2020-2022, there is not much difference in returns of the two over the last three years.

Over next 5 years we expect SPY to do decisively better than QQQ. We are at the end of a massive bubble in equities and this impact is more strongly seen in the QQQ area than in the SPY. While many large cap stocks are present in both, the weights are still different. NVIDIA Corporation Inc. ( NVDA ), for example, is at about 5.2% weight in the NASDAQ 100 versus 2% in S&P 500.

As you can see, the path to 3X sales was interrupted by a new found love of "AI". So we lean here in favor of JEPI as we think it is following the more sensible index.

Secondly, it comes down to what JEPI does via active stock selection. It avoids sectors of the market that are overvalued. Information technology is at 27% of SPY and even higher for the NASDAQ 100.

JEPI comes in here at near 11%. A similar stance can be seen for consumer discretionary.

JEPQ is still leaning very heavily on these overvalued areas.

So JEPI uses active stock selection to get further away from S&P 500 where it needs to whereas JEPQ is still sticking to its benchmark.

Finally JEPI sells calls on the S&P 500 while maintaining a value bent itself. In other words it sells calls on a different set of holdings than what it holds. JEPQ's target for selling calls is very similar to what it holds in the portfolio. So this again gives JEPI the edge for doing a pseudo, "Long Value, Short Growth" strategy via this unusual method.

In all three relevant points, we think JEPI wins. While we don't favor the shorter term call selling, that happens in both funds and is not a distinguishing factor. Hence we think over the longer run (and that is definitely not an opinion on the next 2-3 months), JEPI is the one to stick to. JEPQ rings too close to other NASDAQ 100 covered call ETFs like Global X Funds - Global X NASDAQ 100 Covered Call ETF ( QYLD ).

That is not something we are remotely interested in. At present we rate JEPI a Hold/Neutral and start off JEPQ with a Sell.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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