2023-07-11 07:30:08 ET
Summary
- The JPMorgan Nasdaq Equity Premium Income ETF aims to leverage capital appreciation and generate regular income through its covered-call strategy.
- Despite its aim to reduce portfolio volatility, JEPQ's Sortino ratio has underperformed compared to QQQ's metric over the past year, suggesting a worse risk-adjusted performance.
- The ETF could be more suitable for investors who require regular distribution. However, the risk/reward profile doesn't seem attractive at the current levels.
- Growth and tech investors could do better investing in ETFs that replicate the underlying Nasdaq-100 Benchmark over time.
- For now, staying on the sidelines is encouraged.
Investors in JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) have benefited from its "dual role" of leveraging capital appreciation and generating regular income from its covered-call strategy through its equity-linked notes or ELN.
The actively-managed ETF focuses on building its equity portfolio with stocks in the Nasdaq-100 ( NDX ) ( QQQ ) as the Benchmark. As such, JPMorgan fund managers intend to "capture a majority of the returns associated with the benchmark."
In addition, it sells call options to earn premiums to generate income for its ETF holders. As a result, JEPQ aims to "provide lower volatility compared to the Benchmark over a full-market cycle." The fund manager defines such a cycle to have a duration of about three to five years, as JEPQ aims to provide its investors with a "more stable investment experience."
In essence, JEPQ is likely suitable for investors looking to invest in growth stocks represented in the NDX but also need regular income to supplement their portfolio.
While the aim of reducing portfolio volatility through selling call options is enticing, I gleaned that JEPQ's Sortino ratio has underperformed QQQ's metric over the past year.
The Sortino ratio is a " variation of the Sharpe ratio that differentiates harmful volatility from total overall volatility." As such, it aims to provide keener insights into a security's risk-adjusted returns considering downside risks.
As seen above, JEPQ's most recent Sortino ratio underperformed QQQ's metric, suggesting a relatively worse risk-adjusted performance. The caveat is we don't yet have a full-market cycle to make such a comparison, as JEPQ was incepted only in May 2022.
Despite that, I believe investors need to consider the aim of outperforming the Nasdaq in risk-adjusted terms could be more challenging than anticipated. Hence, I assessed that unless you need to have a consistent distribution from JEPQ's covered call benefit, investing directly into QQQ could deliver more robust risk-adjusted performance over time.
Moreover, the price action in the Nasdaq-100 volatility index or VXN indicates that option premiums are likely at much lower levels now than the highs in October 2022.
While VXN is likely at key support levels, I don't anticipate a sharp spike back into the highs last year, as I don't expect last year's bear market to rear its head again. With that in mind, JEPQ managers could find it more challenging to generate appealing premium income from its covered call strategy.
Despite that, I expect Nasdaq to consolidate in the near term and possibly even experience a steeper decline toward its critical moving averages after a monstrous surge in the first half. As such, JEPQ could close the gap over its underperformance as the Benchmark potentially moves sideways or even fall.
QQQ has significantly outperformed JEPQ over the past year, registering a total return of 25% against JEPQ's 16% upside. Therefore, JEPQ has not delivered superior risk-adjusted performance or on a total return basis.
As a growth and tech investor, I don't need to rely primarily on consistent income to guard against unexpected downside volatility. I can do that on my own for individual stock options that exhibit attractive premiums or are significantly overvalued, in which I don't mind having some of my shares being called away.
Therefore, if I invest in a growth-focused ETF, I prefer to invest in the underlying to extract most of the potential upside over a horizon of at least five years and more.
I must admit that JEPQ's trailing yield of 11.8% is enticing. However, in total return terms, the capital appreciation hasn't demonstrated its appeal, suggesting that it's likely more suitable for investors who require a regular distribution.
While JEPQ could be a beneficial investment if the risk/reward were more attractive, I don't find the current levels in the Nasdaq appealing, as discussed in a recent Invesco QQQ ETF article .
With that in mind, I suggest investors stay on the sidelines for now.
Rating: Hold.
Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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JEPQ: No Longer The Right Time To Be Aggressive