Meet an Active ETF: JEPI

VettaFi: Let’s talk about the equity premium income process used for JEPI. Can you explain the approach to security selection and the options overlay?

Reiner: We think about Equity Premium Income as taking a three-pronged approach to total returns — dividends, options premium, and potential capital appreciation. As a whole, the strategy is seeking 7%–9% annualized income, distributed monthly, with two-thirds of the volatility and beta of the S&P 500.

With Equity Premium Income, there are two building blocks — a more defensive underlying equity portfolio and an options overlay. We specifically chose a more defensive equity portfolio so the strategy does not eat all of the downside in most market environments, and we use a modernized approach to call overwriting that allows us to balance total return and income generation.

VettaFi: JEPI has experienced strong inflows in 2022. What are the benefits of this being an active approach within an ETF? 

Reiner: In today’s volatile markets, we think it’s very important to take a dynamic approach to both our security selection and call overwriting. Our stock selection process is firstly a bottoms-up, fundamental valuation process whereby we identify the most attractively valued stocks from a long-term earnings and cash flows standpoint, then further narrow the universe by finding those attractively valued stocks that also have low volatility from a price and earnings perspective. This approach results in an underlying equity portfolio that is about 0.8 beta to the S&P 500 on a standalone basis.

The beta of the strategy is further reduced by the options overlay to about 0.65. Our options overlay is made up of S&P 500 Index options that are one-month, out-of-the-money call options. In order to dynamically adjust our upside and income to the volatility landscape, we reset a portion of the options on a rolling weekly basis. This laddering and staggering of our options allows us to better balance income with total return. Being able to deliver these active capabilities in the ETF wrapper with all of its benefits has been a huge focus at JPMorgan. We’re excited to be a part of it!

VettaFi: Can you share some examples of changes you made to JEPI’s stock or sector exposure between the beginning of the year and the portfolio we see in the third quarter?

Reiner: We wouldn’t necessarily call out changes to the portfolio, but it’s important to note that the underlying equity will differ from that of a traditional minimum volatility portfolio, as we are not heavily weighted to utilities and consumer staples. We strive to be well diversified across sector and individual name, capping each sector at 17.5% and each individual position at 2%. It’s also important to mention that we do not screen for dividends or dividend growth as part of this process, as we are focused first on the fundamentals. To illustrate this, Google is a holding in the portfolio, and pays no dividend. This well-diversified, more defensive stock portfolio has benefitted the strategy from a performance standpoint year-to-date.

VettaFi: It has been a strong performance year for JEPI, holding up better than the broader market. Is a volatile market an ideal one for this strategy, and in what environment might the fund struggle versus the S&P 500 more?

Reiner: A “best case” environment for the strategy would be when markets are flat to moving up modestly, so you can “have your cake and eat it too.” If markets are gradually moving upward, we should be able to take part in the market’s upside as well as generate income. When we experience elevated market volatility, the strategy can potentially deliver above-average levels of income due to the higher premiums received for selling options. As volatility is a net tailwind to the strategy, we have seen this benefit today in looking at JEPI’s trailing 12-month yield of 9.17% and 30-day SEC yield of 11.93% (as of July 31).

There are a few challenging environments worth mentioning. Challenging environments on the equity side would be a narrow market rally where a few names are supporting much of the market’s growth or when high-quality stocks are out of favor. Our diversified, more defensive portfolio will likely not be able to keep pace with the market in those environments given our position limits and quality bias. A challenging environment on the options side would be a sustained low-volatility environment similar to 2017. In that environment, the strategy may deliver a level of income below that average 7%–9% annualized range.

VettaFi: On the heels of JEPI becoming the largest active U.S. equity ETF, JPMorgan rolled out JEPQ tied to the Nasdaq-100 index in May. What are the similarities between the two ETFs?

Reiner: We are very excited to have launched another addition to the Equity Premium Income Suite: J.P. Morgan Nasdaq Equity Premium Income — JEPQ. Since launching JEPQ only four months ago, the strategy is already over $330M in AUM (as of August 31). JEPQ seeks 9-11% income annualized with ~25% less volatility and beta than the Nasdaq-100, balancing total return and income in a Nasdaq-based product.

Similar to JEPI, JEPQ is comprised of two key building blocks — a fundamentally driven equity portfolio and an options overlay. From an underlying equity standpoint, the portfolio is designed to look and feel like the Nasdaq-100 Index while seeking to own stocks that exhibit less left-tail risk. Our options overlay is made up of one-month, out-of-the-money call options on the Nasdaq-100 Index, and we are selling a portion of the options on a rolling weekly basis in the same way that we do for JEPI. So, for those clients looking for greater Nasdaq-100 exposure in a lower-risk manner, JEPQ is a great solution.

VettaFi: What makes JEPQ different from JEPI?

Reiner: While both strategies are seeking to provide income, the key difference lies in the construction and constituents of the underlying equity portfolios. For JEPI, the underlying equity is focused on high-quality, more defensive S&P 500 stocks, whereas for JEPQ, the underlying portfolio will be similar to that of the Nasdaq-100 Index, which is growthier in nature. We believe the strategies work nicely together in an overall portfolio given the structural underweight to technology in JEPI. We have seen investors using both JEPI and JEPQ together as a way to bring their technology exposure back to S&P 500-like levels, but without sacrificing income in the long run.

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