2023-09-06 17:02:54 ET
Summary
- Investing has become more challenging due to rising rates, high inflation, and slow economic growth.
- Index investing has been less successful in rangebound markets, leading to a rise in alternative investing strategies.
- Covered call funds, like JP Morgan Nasdaq Equity Premium Income ETF, have gained popularity among income investors.
Investing has gotten more difficult recently. With rates rising, inflation levels still above average, and the economy still growing at an anemic pace, markets have been very fluid since the pandemic hit nearly three years ago. Since markets have been rangebound for most of the last several years, index investing hasn't been as successful, and many individuals are increasingly turning to alternative investing strategies.
A type of investment that has become well-known over the last decade, in particular for income investors, is focusing on covered call funds. One of the more well-known funds that used this option-based strategy is the JP Morgan Nasdaq Equity Premium Income Exchange Traded Fund ( JEPQ ). JEPQ has offered investor total returns of 11.82% since the fund's inception in May of last year. The S&P 500 offered total returns of 9% to investors during the same time.
I last wrote about JEPQ in May of this year. I rated the fund a hold primarily because of the uncertain economic and investing environment. I am upgrading my rating to a buy in this article today. I expect markets to be rangebound for some time as the economy appears to still be slowing, although indicators also suggest that a deeper recession is unlikely. JEPQ enables investors to get much of the upside from the core large cap tech holdings that should outperform as the economy recovers next year and the dollar likely also weakens against most major currencies moving forward. This fund is likely to continue to outperform and be able to offer investors solid income and overall returns in the current market environment for some time in my view.
JEPQ loosely tracks the Nasdaq 100, which is obviously part of the overall Nasdaq index. This ETF is less volatile than the Nasdaq 100 since the fund also has 7% of the fund's assets invested in the health care sector, 6.56% in the consumer defensive sector, and 15.39% in the communication sector. JEPQ is 49.62% invested in technology stocks. The fund's top four holdings are Apple ( AAPL ), Amazon ( AMZN ), Alphabet ( GOOG ), and Microsoft ( MSFT ). These four equities make-up 27% of the overall portfolio.
JEPQ sells Equity-Linked Notes against 20% of the fund's portfolio and uses that income as well as the dividends paid by the core holdings to make monthly distributions.
An Equity-Linked Note ('ELN') is a debt instrument, usually a bond, where the payout is based on the underlying asset the option is sold against. The underlying equity of the ELN can be a collection of stocks, a single stock or an equity index. This fund sells one month out-of-the money call options against the individual holdings as well as the index, the Nasdaq 100. The income derived from selling the ELNs along with the dividends paid by the fund's holdings enable this ETF to make monthly distributions.
JEPQ differs sharply from the Global Nasdaq 100 Fund ( QYLD ), because this fund sells out of the money calls against only some of the portfolio. QYLD sells at-the-money call options against all of the fund's holdings each month. JEPQ performs best in a bull market environment with moderately elevated levels of volatility. The fund sells off some of the upside of the equities, so excessive volatility levels can lead to limited upside despite excessive downside risks.
JEPQ should perform well and also continue to offer investors solid income in what is likely to be a rangebound market with an upward bias. Most economic indicators show that even though growth has slowed significantly, the economy should be able to avoid an extended recession. Inflation rates have fallen 11 of the last 12 months, the Fed is likely near the end of the current rate cycle, the job market remains stable, and personal savings levels are still above normal rates right now for most households.
The dollar has also sold-off against the Euro and most major currencies since hitting a 52-week high nearly 6 months ago.
The Nasdaq 100 is more leveraged to the dollar than most indexes since large cap tech companies generate nearly 60% of their earnings from outside of the US. Wall Street also has a bullish outlook for big cap tech in significant part because these companies will face easier year-over-year comps for earnings.
If the economy remains stable and large cap tech companies continue to see strong earnings, the market should be rangebound with a slight upward bias, and a fund such as JEPQ should outperform in this environment for several reasons. This fund strategy of selling out of the money options should not cap most of the upside potential for the portfolio, and the income this ETF is getting from selling these monthly call options should also more than make up for any lost upside because of the strategy used by this covered call exchanged traded fund. Even with volatility levels likely to decline as fears of a broader recession ease, the options strategy this fund uses should still offer decent added income in what I believe is likely to continue to be a flat to slightly up market.
JEPQ has paid out solid income since the fund's inception, and the average monthly payout since the beginning of the year is nearly $0.48 per share, which means the fund is on pace to pay out nearly 10% of the fund's current share price in income.
All different kinds of investors have had to get more creative in the more fluid market environment we have seen since the pandemic hit in 2020, but dividend investors seeking to get inflation adjusted income have had to make larger adjustments than most individuals. With inflation rates still above average and the current growth rates likely to continue to remain anemic, JEPQ should be able to continue to outperform the S&P 500 and most of the broader indexes for some time in my view.
For further details see:
JEPQ: A Fund That Should Continue To Outperform In The Current Market Environment