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Is JEPI a good Investment in 2023? A Realistic Analysis

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Is JEPI a good Investment in 2023?

In the past few months, everybody has been talking about the JPMorgan Equity Premium Income ETF (NYSEARCA: JEPI)  because of a dividend yield that is almost unbelievable: 12%.

There are way too many unrealistic views about this ETF online, so I decided instead to analyze it for you and give you all the necessary information to understand if it’s really worth investing in it or not.

We are going to talk about the Covered Call Strategy of JEPI and how it is going to play out in the future, as well as what you can expect based on the underlying stocks. I’m also going to show you how, although JEPI has only been present since 2020, you can actually know its historical results also for the previous years. 

Now, the big winning point of this ETF is, clearly, the dividend yield, but the important question remains open: what am I going to expect from JEPI in the next years?

JEPI Overview

JEPI – Source JPMorgan

Before we dive into this, let’s see if JEPI meets the basic requirements of a good ETF.

I do have a blog post and also a youtube video where I go in depth over all the criteria that you need to consider when looking for a good ETF and I also help you set up a free Screener, so check them out later if you want. But now a quick recap:

you need to look for a high number of assets under management, a high diversification, a relatively low volatility, low expense ratio and a long track record. 

JEPI is an actively managed fund that invests in a variety of stocks with an emphasis on high quality companies that have a history of stable earnings and attractive valuations.

It provides a good level of diversification thanks to the 136 companies it includes and because of the optimal distribution across the sectors.

The expense ratio of 0.35% could be better, but considering that the fund is actively managed it’s actually low and it’s still a value you can live with because it means you’re going to pay 35$ per year for every 10,000$ you possess of this ETF.

$21.8bn of assets under management also assure you stability and credibility but the great plus is of course the dividend yield of 12.00%.

How JEPI Grows

So in order to analyze this ETF the first point to understand is how it makes money. JEPI seeks an annualized target yield of at least 6–10% and it does it in 3 ways:

  1. Equity Income
  2. Capital Appreciation
  3. Covered Call Options

Equity income

The Equity Income Strategy is when you have companies that pay dividends, giving you lower volatility.

Capital Appreciation

The Capital Appreciation Strategy is when you buy stocks of companies with attractive valuations seeking an increase in market value.

Covered call Option

But the interesting thing is the Covered Call Option Strategy. So here’s how it works:

Let’s say that there is a seller that owns a particular stock and on the other side we have a buyer that is interested in that stock:

The stock is valued 100$, so the buyer could buy it for 100$, but instead, they decide to make a contract for a price of 110$:

This contract is called Call Option and the price of 110$ is called Call Price.

Now, this contract says: buyer, you can buy this stock in the future for 110$, even if the real price has reached a higher price, like 200$. But in the meantime, you regularly pay the seller a so-called Premium, which can be seen like a fee.

So if the price of the stock grows over 110$, the buyer has the advantage to buy it cheaper, at 110$, but he also has the disadvantage that in the meantime he needs to pay this premium

So to execute the covered call strategy, the portfolio manager of JEPI acts as the seller and sells a call on the underlying stocks of JEPI, collecting the premium from the buyers, but at the same time holds an investment in the same underlying assets. So the manager of JEPI is earning when JEPI grows in value, but also because of the premium that they are receiving.

So, when would JP Morgan have the worst payoff and when the best?

The maximum potential loss occurs when JEPI reaches zero, but even in that scenario, the premiums collected from investors are retained since the agreed-upon call price is never reached. This feature is one way JEPI mitigates overall volatility. Conversely, the most favorable outcome arises when the stock price rises just below the call price. In this situation, the underlying stocks can be retained without selling them, while continuing to collect the premium.

This combination of owning the stocks and selling Call Options reduces the downside risk and puts a cap on the maximum potential gains. It works well in a declining market, like the one we’ve had in 2022, by delivering better results with lower volatility. However, in a bullish market, it won’t capture the full upside because once the call price is reached, buyers purchase at that price without benefiting from further growth.

What Factors Influence The Value Of The Option Premium?

Now you are starting to understand that the amount of Premium that JEPI will receive in the future is an important factor for the gains of the ETF. The value of this premium is based on several factors but volatility and interest rates are the primary factors because they are subject to change in different time periods.

As I said, JEPI is seeking at least 6-10% growth and they do it through 1-2% pure dividends, an option premium of 6-8%, and the rest in capital appreciation, which is variable. 

Due to its heavy reliance on the Premium, the fund is supposed to outperform in a high-volatility environment, especially during a market downturn, which aligns with the conditions we have experienced over the past year and a half. However, it is projected to lag behind during a market recovery.

Do Covered Call Strategies Outperform?

Ok, now we know how covered calls work. So now we ask ourselves, do covered call strategies usually outperform the stock market or not? In most cases, they don’t really. If you take for example the Global X S&P 500 Covered Call ETF (XYLD), created in 2013, you can see that the long term returns haven’t outperformed the pure S&P500.

Long term History

Let’s talk about historical results. JEPI started in May of 2020 right after the covid crisis, so of course it grew from the beginning and everybody on youtube can say how great it performed.

But knowing the long term past results is incredibly important to be able to evaluate an ETF. And if you’ve seen other youtube videos on the topic, you’ve probably heard that there is none, because JEPI started in 2020.

Well, it’s not true.

In order to see at least 5 years results, we just need to check the mutual fund equivalent, which is the JPMorgan Equity Premium Income Fund, JEPIX.

JEPIX, being the longer-standing option, provides us with a slightly clearer understanding of what returns to expect. Both JEPI and JEPIX are managed by the same portfolio managers and have nearly identical holdings, with the only notable difference being that JEPIX has a higher expense ratio.

JEPI Fact Sheet – F is JEPIX, B1 is the S&P 500

Over a nearly 5-year period, the fund has slightly underperformed the S&P 500. This could be partly because of the exposure to defensive stocks, the covered call strategy, and also the fact that the fund is actively managed, and usually actively managed funds don’t perform as well as passively managed ones. However, it’s true that the fund doesn’t seek to outperform the S&P 500 so we should criticize it for underperforming, but it’s also wrong to say that JEPI is better just because it performed better in the last 2 years.

JEPI Equity Sectors

But let’s take a closer look at JEPI. JEPI has a big underweight to the information technology sector, compared to the benchmark S&P500, and an overweight to utilities and consumer staples, and this gives us an indication that the portfolio is clearly a defensive Portfolio. This has caused JEPI to lose less than the S&P500 this year but may be an indication that in the long term it will underperform.

Equity Exposure

Let’s see the choice of stocks. JEPI holds an underweight in information technology while being overweight in consumer staples, utilities, and industrials. To see how this played so far, we can take the individual sector-specific ETFs and compare the results of the last 2 years.

In this graph beloy you can see the development of 5 different ETFs. We’ve got:

  1. GPSC, the S&P 500 Index;
  2. VDC, the Vanguard Consumer Staples ETF;
  3. VGT, the Vanguard Information Technology ETF;
  4. VPU, the Vanguard Utilities ETF;
  5. VIS, the Vanguard Industrial ETF.

Looking at the past 2 years, it is clear that the defensive strategy of JEPI has yielded favorable outcomes. The three sectors in which JEPI has an overweight position – consumer staples, utilities, and industrial – have outperformed the S&P500, while information technology has lagged behind. This performance explains why JEPI has been able to generate these returns within a relatively short time frame while maintaining lower volatility.

However, when we extend our sector analysis to the past 5 years, a different picture emerges. During this period, all major sectors of JEPI have underperformed the S&P500, whereas information technology has demonstrated significant outperformance.

If the information technology sector were to experience a sudden and significant outperformance, like it’s happening now, JEPI would likely underperform for two reasons. Firstly, due to its underweight allocation in information technology within its sector composition. Secondly, because the short calls would be triggered.

And in fact, in the past months JEPI has strongly underperformed:

Performance of JEPI since Inception to the 06.07.2023 – Source Seekingalpha

However, I don’t intend to imply that JEPI is a poor investment or that it is bound to underperform in the future. It is entirely possible that the defensive sectors could outperform in the coming decade.

Nevertheless, it’s important to be aware that the growth observed over the past 2 years, along with the generous dividends distributed by these companies, has primarily resulted from a favorable starting point combined with a defensive strategy. It’s uncertain whether this level of outperformance will be sustained in the future.

Upside Potential

Is there an upside potential? Of course there is. We don’t know how the market is going to develop and a flat or declining market with higher interest rates would create larger option premiums and make JEPI outperform in the short term. And let’s not forget that the fund is actively managed so they could also make particular choices to protect themselves from underperformance.

But will the fund be able to keep such a high dividend yield? I don’t believe so.

Who Should Own It and Who Shouldn’t?

In general, I would say that if you are investing for the long term JEPI would probably not be your best option, because higher fees and an active management style won’t likely lead to outperformance in the long term.

And if you stumbled upon JEPI because you love dividends and you want a consistent monthly distribution, also in this case JEPI would not be your best choice because I expect higher volatility in the monthly distributions in the future.

Any investor should be aware of these facts and not only judge a high dividend yield that might not be sustained in the long term. 

The perfect timing of this fund’s inception has surely help to attract a lot of investors but if you were taken by the optimism and invested between mid 2022 and today, you’d be losing by now.

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