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So, is JEPI the best monthly dividend ETF?
Does JEPI give out high monthly dividends consistently?
Is it better than just investing in the S&P 500 index ETF?
Are there any potential risks of investing in JEPI?
Finally, are there any other better alternatives?
How JEPI ETF Works
JEPI stands for JP Morgan Premium Income ETF.
It was designed to capture most of the S&P 500 returns with lower volatility and also give you monthly income.
So, how does it do that?
It does this by buying stocks that are included in the S&P 500 index and then selling Call Options on the S&P 500 index for monthly income.
To achieve lower volatility, JEPI’s fund managers have adopted a more defensive investment strategy to underweight mega-cap and high-growth sectors relative to the S&P 500, exclude stocks that they consider expensive and overvalued, and overweight smaller companies with reasonable valuation.
For example, below is the comparison between the top 10 holdings of JEPI ETF and SPY.
As you can see, the Magnificent 7 (i.e. Tesla, Meta, Alphabet, Amazon, Apple, Microsoft, and Nvidia) accounts for almost 30% of the S&P 500 index as of early Feb 2024.
On the other hand, each stock held by the JEPI ETF does not exceed 2% of its entire portfolio.
Specifically, the Magnificent 7 accounts for less than 10% of JEPI ETF.
To get monthly income, JEPI fund managers sell call options for monthly income.
As they don’t hold all the stocks in the S&P 500 index, they cannot sell covered call options on the S&P 500 index.
So, they use this fixed-income product called equity-linked notes to achieve the same goal.
ELNs are fixed-income products issued by a counterparty that promise a return linked to a reference asset.
Specifically, JEPI holds ELNs that provide exposure to out-of-the-money S&P 500 index call options.
Here’s a quick overview of the difference between JEPI and SPY.
JEPI Performance (JEPI VS S&P 500)
So, how did JEPI perform?
Did it outperform the S&P 500 index?
As you can see, JEPI underperformed the S&P 500 index as of 31st Jan 2024.
When the market rallied from May 2020 until the end of 2021, JEPI was lagging behind the S&P 500 by a large margin.
But, when the market crashed in 2022, JEPI didn’t drop as much as the S&P 500 index.
It outperformed the S&P 500 index during the market sell-off.
During the year 2023, it lagged behind the S&P 500.
Pros & Cons of Investing In JEPI
What are the pros and cons of investing in JEPI?
One of the advantages of investing in JEPI is that it has a lower beta than the S&P 500, which means it is more defensive and would go down less than the S&P 500 during a bear market.
For example, JEPI outperformed the S&P 500 during the selloff in the last quarter of 2018 and the 2022 market meltdown.
It achieved this due to call premiums that it collected and its defensive stocks also helped weather the sell-off.
Another reason why investors like JEPI is that it pays high monthly dividends with a dividend yield ranging from 8% to 12% since inception in May 2020.
Given the investment strategy (overweight defensive stocks and reasonably valued stocks that are included in the S&P 500 index and selling call options on the S&P 500 index for monthly income), the best market condition for JEPI beating the S&P 500 is a sideways market or down-trending market.
Okay, there are always risks when it comes to investing
So, what are the potential risks associated with investing in JEPI?
First of all, when it is a bull market, JEPI will underperform the S&P 500 index.
For example, during 2023, the S&P 500 returned 26.19% while JEPI returned only 9.81%
Also, JEPI trailed the S&P 500 index by 21.3 percentage points between March 23, 2020, and Dec. 31, 2020, when the market staged a strong rally.
If you are a long-term investor, you would lose out significantly when it is a bull market, especially a multi-year bull market.
This is because JEPI’s equity portfolio’s upside is capped by the selling of call options.
Below is the covered call payoff diagram.
As you can see, the profit potential is limited by the strike price of the call options.
To help you better understand, let’s assume you bought 100 shares of a stock at $100 and you sold a covered call on these 100 shares at a strike price of $100 for $3 at an expiry date that is 30 days later.
30 days later, if the stock price is below $103, you keep the $3 premium and also keep your stocks.
However, if the stock price rises to $150, you have to sell all your stocks at $100 even though the current price is $150.
Your profit is kept at $300 only (i.e. the premiums you collected)
If you hadn’t sold call options, your profit would be $5,000.
As you can see, your potential upside is capped.
Another potential risk of investing in JEPI is that its dividend yield might drop in the future.
Since its inception in 2020, its dividend yield has been ranging from 8% to 12%.
However, volatility has been steadily declining during 2023 and JEPI’s annual dividend yield also dropped.
This is because when volatility is high, option selling premium would be high.
When volatility drops, the premiums JEPI can collect from selling options would decrease.
Lastly, there are potential counterparty risks associated with using ELN (equity-linked notes).
If the counterparty defaults, you will not get paid.
To reduce this risk, JEPI fund managers diversify counterparties and only transact with counterparties that have passed their regular counterparty risk monitoring.
Another issue with using ELN instead of selling call options directly is that your tax bill could be higher because income from ELN is considered interest income instead of capital gain.
JEPI VS JEPQ
There are quite a few JEPI alternatives that also pay monthly dividend ETFs by selling call options.
Are these alternatives better than JEPI?
Let’s take a look.
JEPQ (i.e. JP Morgan Nasdaq Equity Premium Income ETF) is very similar to JEPI.
JEPQ is also an actively managed ETF, just like JEPI.
JEPQ tries to capture some of the Nasdaq 100 index returns while creating monthly income by selling call options on the Nasdaq index through the use of equity-linked notes.
On the other hand, JEPI tries to capture most of the S&P 500 index return and sells call options on the S&P 500 index for income.
JEPQ started in May 2022, so the comparison between JEPI and JEPQ in terms of performance will not be very meaningful.
For the past year, the Nasdaq 100 index staged a very strong rally thanks to large-cap technology stocks such as META, Microsoft, and Google.
Therefore, JEPQ performed much better than JEPI.
For investors who want more exposure to high growth technology stocks as well as monthly income, JEPQ could be a not bad choice.
However, you have to keep in mind that technology growth stocks held by JEPQ are much more volatile than defensive stocks held by JEPI.
When the Nasdaq 100 index eventually comes back down, JEPQ’s equity portfolio would likely suffer greater losses than JEPI.
I think the technology stocks are overvalued right now.
So, I will want to wait for a market correction.
JEPI VS XYLD
XYLD is another JEPI alternative.
XYLD is a Global X S&P 500 Covered Call ETF.
Basically, it buys a portfolio of the S&P 500 stocks and also sells (or writes) covered call options on the S&P 500 Index.
The difference between JEPI and XYLD is that XYLD’s equity portfolio closely tracks the S&P 500 index while JEPI’s equity portfolio is actively managed with more weight given to defensive and reasonably valued stocks and less weight given to mega-cap stocks and high-growth stocks.
Another difference is that XYLD sells call options on the S&P 500 index for monthly income because it holds all the stocks in the S&P 500 index while JEPI sells call options for monthly income through the use of ELNs.
Below is the performance comparison between XYLD and the S&P 500 index.
As you can see, XYLD underperformed the S&P 500 index significantly over the past 10 years.
Historically, the S&P 500 index always goes up over time.
So, it is much better just to invest in the S&P 500 index ETF if you are a long-term investor.
If you are looking for monthly income and a more defensive stock portfolio, then JEPI is a better choice than XYLD.