JEPI - Three ETFs: One High-Yield One Dividend Growth And One With A Decade Of Market Beating Returns

2023-07-12 10:51:24 ET

Summary

• I highlight three ETFs that make up over 8% of my portfolio, including the JPMorgan Equity Premium Income ETF, Schwab U.S. Dividend Equity ETF, and VanEck Morningstar Wide Moat ETF.
• JEPI provides robust dividend income and reduced volatility, while SCHD is noted for its strategy to identify high-quality companies that pay hefty dividends.
• MOAT, which tracks the performance of the Morningstar Wide Moat Focus Index, consistently outperforms the S&P.

I’ll readily admit that I’m not a big fan of ETFs. Nonetheless, with a total of 116 tickers in my portfolio, the three funds I highlight constitute over 8% of my investments. In fact, they would comprise a larger share if it were not that I was unaware of one of the names until very recently.

Furthermore, one of these ETFs ranks as my largest position by a wide margin.

The high-yield fund is relatively new, but the other two ETFs have been around for over a decade. This allows us to use the test of time in our efforts to evaluate each fund.

And while we are constantly reminded that beating the market is a near impossible task, one of those ETFs has a history of consistently providing total returns that outperform the S&P 500.

What strategies are used and what sorts of returns can we expect moving forward are addressed in this article.

And despite my aversion to investing in Exchange Traded Funds, I’m well aware that Warren Buffett has repeatedly endorsed index funds as a safe, simple, and surefire path to obtaining financial security.

First At Bat: JPMorgan Equity Premium Income ETF ( JEPI )

JEPI was launched on 05/20/2020. From that date through 05/23/23, $10,000 invested in the fund returned $14,214. During the same time frame, the Vanguard S&P 500 ETF ( VOO ) returned $14,160, excluding dividends.

What JEPI delivers that the S&P 500 does not is a robust and steady flow of dividend income. The current yield is nearly 10.6%. Furthermore, JEPI distributes the dividend on a monthly basis.

The following chart provides insights into how JEPI compares to common sources of passive income.

JEPI generates income by investing in large cap U.S. stocks and by selling options on those holdings. The fund sells call options on a weekly basis to best benefit from the market’s conditions at any given time. Higher volatility is JEPI’s friend, so to speak.

JEPI uses a proprietary method to target stocks that are either overvalued or undervalued and that also have attractive risk/return profiles. This strategy is designed to deliver a recurring monthly income stream from a combination of dividends and option premiums.

JEPI has a goal to significantly reduce volatility in the share price. With a peak decline of 13% last year, versus about a 25% loss by the S&P 500 and the 33% loss in the NASDAQ, management hit that target.

It is important to note that despite the ETFs relatively short tenure, JEPI has performed well during a market downturn, a bull market, and a sideways market. This lends some credence to the idea that the fund cannot just survive but thrive over the long term.

Even so, investors must understand that JEPI is not designed to deliver market-beating returns. To the contrary, management’s stated goal is to generate total returns of 8% to 9%.

It is also of importance to understand that the bulk of the income generated by JEPI is in the form of Equity-Linked Notes (ELNs).

Finance Strategists provides the following definition of ELNs:

Equity-Linked Notes (ELNs) are structured financial instruments that combine the features of both fixed-income securities and equities. They provide investors with the potential for higher returns linked to the performance of an underlying equity or equity index, while still offering regular income through coupon payments.

On one of J.P. Morgan’s sites, I found the following JEPI risk summary.

Investments in Equity-Linked Notes (ELNs) are subject to liquidity risk, which may make ELNs difficult to sell and value. Lack of liquidity may also cause the value of the ELN to decline. Since ELNs are in note form, they are subject to certain debt securities risks, such as credit or counterparty risk. Should the prices of the underlying instruments move in an unexpected manner, the Fund may not achieve the anticipated benefits of an investment in an ELN, and may realize losses, which could be significant and could include the Fund's entire principal investment.

Admittedly, it is common practice for companies to post worst case scenario warnings for investors, but I believe many holders of JEPI are unaware of this risk.

JEPI has a reasonable expense ratio of 0.35%.

Be aware that ELN income is taxed at ordinary rates. Therefore, JEPI should be held in untaxed accounts.

I hold a small to moderate position in JEPI. I acknowledge that over the long term, total returns from this ETF are likely to lag the market; however, I use it as a vehicle to generate a stream of passive income and to diversify that portion of my portfolio dedicated to high yield investments.

Next Up: Schwab U.S. Dividend Equity ETF ( SCHD )

Morningstar provides the following overview of SCHD’s strategy:

“This fund fully replicates the Dow Jones U.S. Dividend 100 Index, which features 100 stocks that have paid dividends for at least ten consecutive years and boast the financial health to continue their streak."

The ETF also utilizes seven quality measures to further screen for stocks. SCHD does not include REITs in the portfolio.

With an expense ratio of 0.6%, management utilizes a strategy to identify high-quality companies that pay relatively hefty dividends. Holding roughly 100 stocks at any given time, and generally investing no more than a mid-teens percentage into any single sector, SCHD maintains a reasonably wide degree of diversification.

The following charts provide insights into the ETFs holdings.

Seeking Alpha

Over the last eleven years, the worst annual total return for SCHD was -5.56%. That was back in 2018. In that time span, SCHD provided double-digit total returns over eight years. On average, the total return from 2012 through 2022 was 14.21%.

Schwab gives SCHD a 5-year and 10-year rating of five. For historic returns, SCHD is rated as a five, and for risk, the ETF receives a two.

The 3-year rating for SCHD is four. I suspect the rating would be higher were it not for the ETF’s performance over the last year.

From my perspective, the relatively poor performance of late provides a buying opportunity. Dividend bearing stocks are out of favor at this juncture, so I contend the time to buy is while yields are high.

The current yield for SCHD now stands at 3.59% while the average yield in 2020, 2021, and 2022 was 3.34%, 2.87%, and 3.15%, respectively.

Excluding dividends, the 5-year return is just over 44%, and the 10-year return is nearly 113%.

SCHD is by far my largest holding. I’ve been adding to my position steadily throughout this year, and I will continue to do so as long as the above average yield persists.

The Home Run Hitter: VanEck Morningstar Wide Moat ETF ( MOAT )

MOAT tracks the performance of the Morningstar Wide Moat Focus Index (MWMFTR).

To be included in MWMFTR, Morningstar must rate a stock as possessing a wide moat. One requirement for rating a company as wide moat is that Morningstar analysts must be “ very confident” that a firm will generate ROIC in excess of cost of capital over the next 20 years.

To be assigned a wide moat, a company must possess one or more of the following attributes; Switching costs advantages, intangible assets, and/or assets that provide a network effect, such as cost advantages, and/or efficient scale.

Another consideration for inclusion in MWMFTR is that a stock must be trading at a low valuation. While MWMFTR usually consists of around 145 stocks, MOAT selects the 50 companies with the lowest valuations among those listed. However, once a stock is selected for MOAT, it must be rated below the top 60 in valuation before it is removed from the ETF’s portfolio.

Unlike SCHD, MOAT permits fairly heavy exposure to single sectors. At any given time, a sector may comprise up to 40% of the ETF’s holdings.

As of the end of June the sectors were weighted as follows: Information Technology comprised 21.24% of holdings, Health Care 18.09%, Financials 15.76%, Industrials 15.11%, Consumer Discretionary 9.92%, and Consumer services, Materials, and Consumer Staples, 8.91%, 6% and 4.97%, respectively.

The top ten stocks at the end of June were TransUnion ( TRU ) 2.73%, Tyler Technologies ( TYL ) 2.7%, Domino’s Pizza ( DPZ ) 2.64%, Ecolab ( ECL ) 2.6%, Intercontinental Exchange ( ICE ) 2.57%, Veeva Systems ( VEEV ) 2.57%, Alphabet ( GOOGL ) 2.56%, Salesforce ( CRM ) 2.56%, Polaris ( PII ) 2.54%, and Zimmer Biomet ( ZBH ) 2.54%.

Investors that follow MOAT closely will note that the weighting of both sectors and stocks can vary markedly over a relatively short period of time. That is because the ETF is reconstituted twice annually, with that process being staggered on a quarterly basis. In other words, half of the portfolio is reconstituted one quarter with the other half being reconstituted the following quarter.

MOAT has a reasonable net expense ratio of 0.46 percent. The ETF yields 1.02% and has a 5-year dividend growth rate of 12.23%. Prospective investors should be advised that the distribution is paid on an annual basis.

MOAT consistently beats the S&P 500 in terms of total return.

Over the last ten years, the average annual total return for MOAT is 14.07% versus an average annual total return for the S&P 500 of 12.86%.

Morningstar gives an overall rating to MOAT of 5 stars. The historic risk and return are both rated as high.

Summation

I rate both JEPI and SCHD as buys at this juncture; however, that comes with a caveat. Investors should be aware that JEPI is not designed to provide market-beating returns. Furthermore, there is an element of risk related to the ETF’s use of ELNs to generate income.

While I heartily recommend investors consider adding MOAT to their portfolios, I believe that ETF is trading at an unfavorable valuation.

I own positions in all three ETFs.

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