Move Over, JEPI. JEPQ Is Catching Fire

JEPI, one of this year’s hottest ETFs has a lesser-known sibling, JEPQ, that’s catching fire. 

The JPMorgan Equity Premium Income ETF (JEPI) has seen exceptional demand from investors this year. With $10.7 billion of year-to-date inflows and $28.8 billion in assets under management (up from $17.5 billion at the start of the year), JEPI has been a superstar. 

But JEPI isn’t the only “premium income” exchange-traded fund from JPMorgan catching investors’ attention. The JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) has also seen its assets under management balloon. Since the start of the year, it’s amassed $3.2 billion of new money, bringing its AUM up from around $1 billion to $4.6 billion. 

JEPQ and JEPI employ nearly identical strategies—except for the fact that the latter selects stocks from the S&P 500, while the former selects stocks from the Nasdaq-100.  

That makes JEPQ a much more tech-heavy fund, something that’s paid off in a year in which tech stocks have soared. On a year-to-date basis, the ETF is up 27.9% versus 7.1% for JEPI.  

JEPQ and Equity Linked Notes 

Like JEPI, JEPQ’s strategy might be a bit hard to understand at first. The fund invests in equity-linked notes, a type of debt that provides returns linked to underlying instruments within the ELNs.   

In JEPQ’s case, these ELNs mimic the returns of a Nasdaq-100 covered call strategy. This type of strategy, which we see in funds like the Global X Nasdaq 100 Covered Call ETF (QYLD), generates yield at the expense of capping price appreciation potential.   

The ELNs that JEPQ owns convert the options premiums received into coupons that are distributed monthly. JEPQ invests up to 20% of its net assets in these ELNs.  

The rest of the ETF is invested in what you could call a low volatility value strategy. Undervalued stocks are selected from within the Nasdaq-100 universe and then put together in a way that creates a portfolio that has lower volatility than the index. ESG factors may be used as well in stock selection.   

The result is a tech-heavy portfolio with lower volatility and a higher yield than the Nasdaq-100, but also one whose returns are dependent on the stock-picking abilities of JEPQ’s managers.   

JEPQ vs QQQ

Today, JEPQ’s portfolio doesn’t look all that different from the Nasdaq-100. The top eight holdings of the ETF are the same as the top eight holdings for QQQ. But whereas those eight stocks make up 46% of QQQ, they make up only 40% of JEPQ. 

There are some other differences as you get deeper into the portfolio, but make no mistake, this is an ETF that adheres pretty closely to its benchmark; it’s not one that’s shooting for the fences like the ARK Innovation ETF (ARKK). 

It’s easy to forget with all the talk about covered calls that JEPQ is still an active equity ETF. The decisions that the fund managers make go a long way toward shaping the ETF’s portfolio and determining its returns—decisions that include which stocks to hold and in what proportion.

JEPQ “is designed to provide investors with performance that captures a majority of the returns associated with the benchmark,” says the fund’s prospectus.  

JEPQ, Covered Call Positions and Stock Holdings

Unfortunately for investors in JEPQ, this year, the ETF hasn’t lived up to that promise. The fund is up 27.9%, but that sharply lags the 44.3% return for QQQ.  

It’s hard to disentangle exactly how much of that variance comes from the performance of JEPQ’s stock holdings and how much comes from its covered call positions—but there’s little doubt that the majority of the underperformance comes from the latter.  

Covered call strategies tend to underperform when markets are rising. That’s the deal that investors make: give up some upside in return for guaranteed income (JEPQ’s 10.7% SEC yield isn’t a free lunch).   
When markets rise slowly, the upside that investors give up might not be much, and could possibly be made up for entirely by the income received. But when markets rise quickly, as they’ve done this year, the lost upside can be significant. 

That’s what’s happened to JEPQ in 2023. It’s employed a covered call strategy as the Nasdaq has exploded to the upside—which is precisely the worst time to use that type of strategy.

A similar story has played out with JEPI. Its 7.1% gain pales in comparison to the 20.7% return for the SPDR S&P 500 ETF Trust (SPY), largely because it’s been selling covered calls while the market has been soaring.   

JEPQ vs Stock Market Rally  

Given these dynamics, the massive success of JEPI and JEPQ this year is a bit of a headscratcher.  

There’s nothing wrong with covered call strategies per se, but you would expect investors to gravitate toward them when markets are flat or declining, periods when they are more likely to outperform. 

Perhaps investors’ skepticism about the stock market rally has contributed to the demand for these funds.  

For much of 2023, ETF investors didn’t believe in the stock market rally. Up until the end of May, investors had added nearly no new money to U.S. stock ETFs.  
 
Many didn’t expect the stock market could perform well at a time of rising interest rates and elevated recession risks. For them, a low volatility, high income portfolio with a value tilt made sense. 

But that skepticism has (so far) proven to be misplaced. The market has rocketed higher, turning JEPQ and JEPI into laggards.  

Some investors in these ETFs might not care. They went in with the assumption that these funds would underperform in a strong market environment and that’s exactly what’s happened. 

Others might be feeling a bit of FOMO. Leaving 1,640 basis points of return on the table (the difference between JEPQ’s return and the QQQ’s return this year) probably doesn’t feel great. 

How an investor in JEPQ feels today largely comes down to expectations. These are ETFs that are going to underperform their benchmarks in most years because markets usually go up. 

On the other hand, if they’re managed well, maybe they can provide a level of income and risk-adjusted returns that a certain segment of investors is looking for. But even that remains to be seen.