JEPI - SCHD Vs. JEPI: Totally Different Strategies But With A Similar Goal

2023-07-07 06:17:51 ET

Summary

• The article compares two dividend ETFs, Schwab U.S. Dividend Equity ETF (SCHD) and JPMorgan's Equity Premium Income ETF (JEPI), highlighting their different strategies and potential returns for investors.
• JEPI uses a covered call strategy with high-growth tech stocks, while SCHD focuses on higher-yielding companies, offering different sector exposures and revenue growth potentials.
• Both funds have a similar goal: to provide a higher-than-average dividend yield. Despite that, both employ totally different strategies.

Introduction

In my last article , I performed a deep dive into two ETFs: Schwab U.S. Dividend Equity ETF (SCHD) and iShare's (DGRO). That article got me thinking... is SCHD truly the best dividend ETF for all investors seeking cash flow today and a total return?

Many investors, such as myself, enjoy the sweet feeling of seeing a dividend hit your bank account, or for the old school investors, a physical check mailed to your home address. It's one of the small simple pleasures of investing: to see the incremental progress you are making towards whatever your financial goals... For some, it's retirement, for others a home, everyone has their reason.

But before that great feeling of receiving a dividend can be experienced one must decide where to invest one's money. And there are tons of dividend ETFs out there many of which boast a similar strategy.

To help solve the mystery, in my upcoming articles, I plan on exploring those different strategies more deeply, as part of that series, today I'd like to compare Schwab's (SCHD) and JPMorgan Equity Premium Income ETF (JEPI), an ETF with a covered call strategy.

Why JEPI?

Why am I looking at JEPI? Well JEPI is unlike many other traditional dividend ETFs, yes it still targets a high yield to provide investors with cash flow, but it focuses on higher growth names that are missing in most dividend ETFs. In fact, many of the holdings pay no dividends at all.

So how then, if many of its holdings pay no dividend, do its distributions look like this?

And how does the yield look like this?

Well, actually, I did just tease it, it's through the implementation of a covered call strategy. Let me try to explain with a hypothetical.

Imagine you own 100 shares of stock, maybe the stock pays no dividend, but you still want to make some extra money from the stock without selling shares to help you cover day-to-day expenses.

This is where a covered call strategy can be useful.

A covered call strategy is when you sell someone else the right to buy your stock at a specific price (the strike price) for a certain period of time. In return for giving them that right, you receive a premium (cash). If the stock price stays below the strike price, you keep the premium and your stock. But if the stock price exceeds the strike price, the buyer can exercise their right and buy your stock from you. The net effect is you put a cap on short-term upside potential in exchange for a premium, thereby producing cash flow.

JEPI uses that covered call strategy with high-growth tech stocks but with an added benefit. Through the wrapper of an ETF, individual investors need not worry about executing and rolling over the option contracts on their own as it is all handled by JPMorgan in the ETF wrapper making JEPI much more convenient.

Why SCHD?

Well, I don't want to rehash my last article as to why I am so fond of this fund, I will provide a brief summary of some of the key reasons why it is so popular. I don't want to spoil the entire article at this stage, but as a primer, it's one of the few high-yield ETFs that has been able to keep up with the market (depending on the time frame, even outperforming the market).

Without further ado, let's start the comparison. Just like last time, within this article I'll be comparing the performance of these funds over time, their holdings, sector allocations, and more.

High Level

Let's cover the basics first. SCHD has ~$47 billion Net Assets spread across 104 holdings with an expense ratio of just 6 basis points, that's 0.06%. JEPI has ~$28 billion spread across 136 holdings with an expense ratio of 35 basis points, 0.35%.

First off, both of these funds are massive, yes they are dwarfed in AUM by stalwarts like ( SPY ) but within the dividend ETF space, these are huge. Next, these funds are both concentrated, 104-136 holdings are quite concentrated when you consider that the S&P 500 has 500 companies inside of it (shocking, I know).

A note on the expense ratios, first, 6bps is dirt cheap, not only for a dividend ETF but even compared to vanilla-market cap ETFs. 35bps on the other hand, is more "average" but I will caveat that statement with this: running a covered call option strategy is much more labor-intensive than a pure vanilla strategy, 35bps when taking the operational complexity into consideration is actually not all that expensive.

Total Return

Now let's jump ahead a bit before I dive into the holdings. what do the returns look like for these funds?

Given the shorter operating history of JEPI, it's hard to make any definitive conclusions from the above chart. What is clear is that the tech exposure helped them outperform in 2020 and 2021 but was a major headwind in 2022.

While these funds have performed well since 2020, over the past 12 months performance has been somewhat lackluster, both funds are trailing the S&P after many mega-cap stocks took off over the past couple of months, perhaps riding on the hype of AI.

Holdings

As I mentioned earlier, both funds are relatively concentrated, holding just around 100 holdings. While that is true, JEPI is far less concentrated in its top 10 holdings where the 10 largest holdings only make up ~15% of the portfolio compared to 41% for SCHD.

As you can see there are a couple of non-dividend paying companies in JEPI's holdings, Adobe, and Amazon are the two big ones. In general, JEPI holds many lower-yielding companies, while SCHD focuses on those which are higher-yielding.

Dividend Yield

YCharts helps to confirm this for us, as you can see amount the top 4 holdings of each ETF, JEPI's holdings are yielding less than 1% whereas all 4 of SCHD's are yielding greater than 2%.

Conversely, due to its covered call strategy, JEPI as a fund yields significantly more than SCHD, which already yields more than the market as a whole. Investors should note though, that in exchange for this higher yield, you are capping some of your upside potential.

Revenue Growth

Unsurprisingly, when looking at revenue growth the holdings of JEPI shine compared to that of SCHD. Comparing the top 3 holdings within each fund we can see that over the past 5 years, JEPI's holdings have increased their revenue by 81-138% whereas SCHD's holdings have increased revenue between 4 and 73%.

Valuation

But revenue growth on its own is not everything, valuation matters too, and JEPI's holdings are just more richly valued, on average, compared to SCHD.

The top 3 holdings of JEPI all trade between 24x to 30x EV to EBITDA whereas the top 3 holdings of SCHD trade between 6x and 19x, quite the difference! So yes, you have growth at JEPI, but at a high cost when looking at the individual holdings.

Sector Exposure

Another major difference between these two funds is their different sector exposures, while SCHD is skewed heavily towards industrials and health care, JEPI skews toward technology, communications, and "other" (options contracts).

Controlling for those options contracts, we can see much more clearly where JEPI's sector exposure lies.

Something that surprised me performing this analysis is that JEPI is actually much more diversified across sectors than SCHD is. Utilities, Communications, and Real Estate are areas where SCHD has minimal exposure.

Despite sharing a dividend yield focus, both of these ETFs provide wildly different exposure and implement totally different strategies, the sector exposure differences are further evidence of this.

Conclusion

Both of these funds have seen wild success in terms of fund inflows, and it's no shock, as they appear to be great funds. These two ETFs provide investors with exposure two to different segments of the market while both delivering an above-average yield for cashflow-conscious investors.

So, depending on the goals of the individual investor I believe both funds could make sense...

If one desires the highest yield possible with a decent total return, JEPI makes sense. If one desires a higher yield, doesn't want to complicate their portfolio with options, or prefers a value investing strategy, then SCHD could make a lot of sense. As for myself, I am in the latter category.

I rate both SCHD and JEPI a "Buy".

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