JEPI, JEPQ: Are Covered Call ETFs Overdone?
To paraphrase the late Yogi Berra, the ETF industry may be suffering from déjà vu all over again. I am not as much a tracker of fund flows as the many outstanding pros in the industry are. So, when something in the flows area catches my eye, I want to alert people to it.
For many following this segment of the ETF world, the JPMorgan Equity Premium Income ETF (JEPI) is where the conversation starts and ends. That’s what $31 billion in net inflows since the start of its first full year (2021) will do to help a fund grow. But that’s asset flow, as tracked nicely by etf.com’s ETF flow tracking tool.
What that data also shows is that JEPI’s asset surge peaked in January of 2023 at an amazing $2.4 billion in that single month. Flows continued to be strong until just a few months ago and are recently back around the levels from early 2021.
Investors are notorious for chasing performance. And clearly, not enough time has passed to judge whether the rush into that ETF was a sign of a peak in its ability to generate alpha. That was a long-standing issue in the mutual fund industry, as managers would lose flexibility as their fund’s asset base became too large. ETFs are a different beast, but Wall Street has a long history of seeing a product area get very “hot” only to have that mark the best of times.
JEPI, JEPQ and Other Covered Call ETFs
But there are other follow-on events that typically occur after the success of an ETF like JEPI, and those do not need more time to evaluate. One is the ability for JEPI’s manager to strike ETF “gold” again with the JP Morgan Nasdaq Equity Premium Income ETF (JEPQ). That fund has the same basic objective and process as JEPI, except that its stock selection is tied more closely to the Nasdaq 100 index. JEPI is more closely tied to the S&P 500, though both ETFs are actively managed, so they can stray from those benchmarks. In fact, neither fund has an official benchmark.
JEPQ debuted in May, 2022, and started gathering steam in terms of fund flows around the time that JEPI was peaking. It has already topped $500 million in inflows this month, the ninth straight that has occurred, after not seeing those types of inflows in any three months combined prior to that. Lightning strikes fast in the ETF business.
Those flows are such a large percentage of total flows into the covered call ETF category, even the two biggest peers combined (Global X and First Trust) can’t even make a dent. But while flows are impressive, ultimately what investment advisors want for their clients, and what self-directed investors want for themselves, is performance. And in the past, from the dot-com bubble to mortgage bonds before the financial crisis and even back to “portfolio insurance” pre-1987 crash, there has always been a dominant source of investor and industry attention. And often, the popularity is not sustainable.
Innovation and Covered Call ETFs
As for covered call ETFs, there are innovations galore. Some now only cover part of the portfolio with options to allow more upside. Others add put option purchases to the call option sales that drive the ETFs’ income, to introduce an element of “tail risk protection.” And other products are now structured by staggering the amount to which the calls are out of the money and time to expiration to allow for more upside.
These innovations are a clear sign that product providers see sustained demand for option-assisted equity ETFs. The number of funds has grown quickly, even if most of the money is going to the industry leaders. There are some “first mover” advantage there, though it should be noted that ETFs of this type have been around since the Invesco S&P 500 Buy Write ETF (PBP) launched way back in 2007. And, while that fund’s annualized 10-year return of 5% is well behind the unhedged S&P 500 index, it is more than three times the 1.6% annualized 10-year return of the iShares Core US Aggregate Bond ETF (AGG).
Investors decide for themselves if and where covered call ETFs fit into their broader portfolio plan. But it is worth following the progress of the asset giants in this field, to see if they get too big to perform the way they did in during the period that investors responded to by throwing assets at them in record numbers. For instance, over the past 12 months, JEPI has trailed two of its peers, the Global X S&P 500 Covered Call & Growth ETF (XYLG) and the First Trust Buy Write Income ETF (FTHI) by nearly a two-to-one margin (24% and 21% respectively, versus JEPI’s 12%). That’s only one data point, but it speaks the potential for underperformance to follow assets. Buy low, sell high is not an automatic in investor behavior.
