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JPMorgan Nasdaq Equity Premium Inc ETF JEPQ

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Morningstar’s Analysis JEPQ

Medalist rating as of .

No free lunch.

Our research team assigns Neutral ratings to strategies they’re not confident will outperform a relevant index, or most peers, over a market cycle on a risk-adjusted basis.

No free lunch.

Analyst Lan Anh Tran

Lan Anh Tran

Analyst

Summary

JPMorgan Nasdaq Equity Premium Income provides attractive income by forgoing the upside of its growth-heavy index. The strategy benefits from an experienced options manager and thoughtful implementation, but downside risk and opportunity cost weigh heavily on this fund.

This fund combines a systematic approach to selling one-month call options with an underlying equity portfolio that stays close to the Nasdaq-100 Index. The manager targets 30-delta out-of-the-money calls, leaving modest room to capture the index’s upside. He reduces the path dependency of its options strategy by staggering its one-month calls into weekly tranches. The fund uses equity-linked notes, or ELNs, that mimic the profits on written call positions instead of holding the options themselves. Tax treatment of ELNs is often favorable for capital gains on equity returns but can be disadvantageous for options profits. ELNs carry additional counterparty risk, but the team at J.P. Morgan diversifies its issuer risk and transacts only with global financial institutions that pass their regular counterparty risk monitoring.

Using a more volatile and growth-leaning index allows the strategy to capture larger volatility risk premiums but runs the risk of eroding total returns over a full market cycle. The eye-catching premiums that the fund has paid out so far have come from selling the upside on the Nasdaq-100 Index, which consists mostly of high-growth stocks. During rallies, the fund doesn’t participate past the short call strike price and pays out its call premiums and dividends as distributable income. The strike price on its calls averaged around 2.5% historically, its upside cap for the one-month period of the calls. For context, more than 40% of the index's monthly returns since its inception exceeded 2.5%, with most up-months clocking in between 2.5% and 7.5%. The fund’s short track record has so far coincided with high implied volatility and high interest rates, which boded well for its call premiums. However, it’s unclear whether the income will be enough to compensate for the forgone upside on the Nasdaq-100 Index in the long run when market volatility calms down.

During drawdowns, this strategy’s options income offsets some losses, and the higher implied volatility often translates to higher call premiums. However, sharp declines and the high volatility associated with the Nasdaq-100 Index exposes the fund to material downside risk. The equity sleeve has offered modest incremental improvements over the index, which may address this issue on the margins. But tight tracking error allowance and similar beta exposure leaves it exposed to much of the same risk.

The fund’s assets have grown exponentially since the beginning of the year, amassing more than $5 billion as of August 2023. Its options are currently based on the Nasdaq-100 Index, which raises some capacity concerns. The high value of the index (about $15,000 as of September 2023) translates to a higher notional value for its options and creates unique challenges for the fund. Options volume on the index tends to be low relative to its high open interest. While it’s a popular index with ample committed capital, traders navigate more toward the smaller contracts on Invesco QQQ Trust QQQ, an exchange-traded fund that tracks the same index but has lower notional value on its options. Nonetheless, the managers have tools at their disposal to manage capacity, such as further staggering options trades or by using QQQ options, if deemed necessary. Laddering the options on a weekly basis, which they are already doing, also helps.

Rated on Published on

The cost of capping upside on a growth-heavy index limits the benefit of a nuanced options overlay.

Analyst Lan Anh Tran

Lan Anh Tran

Analyst

Process

Average

The fund earns an Average Process rating.

This strategy owns an equity portfolio that resembles the Nasdaq-100 Index while systematically selling one-month calls on the index to generate distributable income. The manager writes 30-delta out-of-the-money calls, whose strike prices fluctuated around a historical average of 2.5% above the index price. The strike price of 30-delta call options can increase further out of the money during periods of heightened volatility, typically during market downturns. This caps the strategy’s upside at the strike price for the duration of the call. While this captures an increment of upside compared with peers that sell at-the-money calls, the strategy still forgoes substantial upside on the volatile Nasdaq-100 Index. The manager sells a portion of the total call positions every week to diversify the strike price/call premiums, and reduce path dependency.

The fund packages its calls into an ELN instead of directly shorting the call options. This turns call premiums, which are taxed as capital gains, into interest income, which are taxed as ordinary income. This structure avoids the straddle or mixed-straddle tax identification that most peers have, which often recognizes all gains on the equity sleeve as short-term capital gains and preclude equity dividends from a reduced tax rate for being qualified. Depending on the market conditions, some peers also have to distribute part of their premiums as a return of capital, which is not taxable income but reduces an investor’s cost basis. However, the fund loses the ability to recognize a portion of its options profits as long-term capital gains, whose tax rate is often more favorable. Its higher-than-average payout should compensate for this tax treatment for most investors in lower tax brackets.

The use of ELNs also invites additional counterparty risk. The fund often invests around 15% of its assets in ELNs, below the 20% regulatory cap, and spreads its ELNs across four to five issuers to stay under the 5% issuer-level cap. The management team is only allowed to transact with large global financial institutions, typically global systematically important banks, or G-SIBs. They purchase ELNs from issuers offering the best income through a competitive auction process, which should tame the commission spread.

Applied data science powers the equity sleeve on this portfolio. The model generates a distribution of expected returns for each stock, drawing on historical forecasts from J.P. Morgan’s broad team of equity analysts, company fundamentals, and alternative data sources, such as global supply chain data. The final equity portfolio mimics the Nasdaq-100 Index within a thin tracking-error band of 2%-3% while seeking incremental improvements on stocks with better risk/reward profiles.

Given the tracking-error target, the equity sleeve does not stray too far from the Nasdaq-100 Index. Both its sector exposures and top holdings trace the composition of the index within basis points. Additional constraints further tether the equity portfolio to the index. Individual positions can deviate by up to 2 percentage points, though most stocks typically stay within 1 percentage point of their index weightings. The managers hold some off-benchmark names but limit their combined weighting to 20% of the portfolio, so active share remains low at 16% as of August 2023.

The growth-heavy lineup of the Nasdaq-100 Index doesn’t generate substantial dividends and the equity sleeve doesn’t specifically target them, so most of the distributable income comes from call premiums. The strategy has typically paid out 80-120 basis points in monthly distributable income since its May 2022 inception. This is partly thanks to the recent high-volatility and high-interest-rate environment that pushed premiums higher, but over the long term this figure will likely fall lower.

Covered calls effectively cash in on a fixed rate of the index’s upside. These payouts help cushion the strategy’s performance during downturns and add value during sideways markets when the index does not breach its strike price. However, the options overlay detracts from performance when the index climbs past the upside cap and when lower implied volatility decreases call premiums. Staggering the options in weekly tranches can cause short-term deviations from expectations based on monthly index performance, but this should smooth out over the long run.

Rated on Published on

An experienced manager heads up this strategy, supported by a promising team on the equity sleeve.

Analyst Lan Anh Tran

Lan Anh Tran

Analyst

People

Above Average

The fund earns an Above Average People rating.

The systematic implementation of the options overlay strategy and the quantitative nature of the equity sleeve alleviates concerns about the smaller size of this team. Lead portfolio manager and strategy architect Hamilton Reiner joined the firm in 2009 and has three decades of experience in derivatives markets. Prior to joining J.P. Morgan, Reiner held senior positions across Wall Street at Barclays Capital, Lehman Brothers, and Deutsche Bank, and he spent the first 10 years of his career at O’Connor and Associates, an options specialist firm. He is supported by two junior portfolio managers who joined from the ranks of the equity analyst team, and a strong supporting institutional framework at J.P. Morgan.

Eric Moreau and Andrew Stern utilize Applied data science to construct the equity sleeve on this fund, subject to tight constraints to the Nasdaq-100 Index. Moreau and Stern joined J.P. Morgan in 2014 and 2008, respectively. Both are comanagers on JPMorgan US Applied Data Science Value JPIVX, where they employ a similar process to a different universe of stocks. While the equity sleeve team is thinner than traditional analyst-driven teams, it’s essentially an optimized index fund that hews close to the index and does not require significant analyst resources.

Rated on Published on

Building on a solid foundation, J.P. Morgan Asset Management maintains an Above Average Parent rating.

Associate Director Alyssa Stankiewicz

Alyssa Stankiewicz

Associate Director

Parent

Above Average

J.P. Morgan is a well-resourced, diligent, and responsible steward of client assets. Investment teams are seasoned and stalwart, especially in equity and fixed income, the latter of which has successfully undergone substantial transformation in recent years. The firm offers competitive compensation that is aligned with fundholders and shows strong retention at senior levels of the organization. It demonstrates a culture of constant innovation and willingness to evolve. For example, J.P. Morgan recently expanded its investment committee process through which senior leaders review various teams and strategies, and it continues to develop proprietary portfolio management and risk oversight tools. Some funds still face high fee hurdles, but the firm has generally lowered expenses as it has grown.

The firm isn't without its complications. J.P. Morgan's product offering is extensive, and some areas need improvement. For instance, its multi-asset business has faced some challenges as a result of complex investment processes. The firm continues to build out its footprint in China, but its efforts there remain unproven. Although not every strategy is the best in its class, J.P. Morgan remains earnest in the pursuit of excellence, and investors are well-served.

Rated on Published on

This strategy’s performance has met expectations.

Analyst Lan Anh Tran

Lan Anh Tran

Analyst

Performance

It outperformed the Nasdaq-100 Index during drawdowns when its call premiums added to total returns. From its May 2022 inception through December 2022, the U.S. ETF vehicle outperformed the index by 5.6 percentage points with lower volatility. It captured only 74% of the index’s downside over this period.

However, capping upside leaves this strategy trailing the index during gains, save for sideways markets like April 2023 when the index rose by 0.52%. Despite outperforming in 2022, the strategy lagged the index as markets recovered in 2023. The Australian ETFs were acutely affected, as their shorter track record spanned a steady market rally between May and August 2023. They substantially lagged the Nasdaq-100 Index over this period because they missed out on a large portion of the index’s upside. The U.S. ETF fared better over its longer track record but still lagged the index by 4.4 percentage points annualized from its May 2022 inception through August 2023.

Nonetheless, writing the call options provides a cushion and lowers the strategy’s volatility. The since-inception standard deviation of returns for the U.S. ETF stood at 23.84% annualized, versus the index’s 33.7%. As of August 2023, its trailing 12-month yield sat at 11.5% thanks to higher implied volatility and interest rates in recent markets. The Nasdaq-100 Index has more upside potential and volatility than other major indexes used by covered-call strategy peers, notably the S&P 500, and thus commands a higher premium on its calls. However, investors should be cognizant that this high level of income is not guaranteed over the long run.

Published on

It’s critical to evaluate expenses, as they come directly out of returns.

Analyst Lan Anh Tran

Lan Anh Tran

Analyst

Price

Based on our assessment of the fund’s People, Process, and Parent Pillars in the context of these expenses, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Medalist Rating of Neutral.

Published on

Portfolio Holdings JEPQ

  • Current Portfolio Date
  • Equity Holdings
  • Bond Holdings
  • Other Holdings
  • % Assets in Top 10 Holdings 42.6
Top 10 Holdings
% Portfolio Weight
Market Value USD
Sector

Apple Inc

7.37 1.1 Bil
Technology

Microsoft Corp

7.05 1.1 Bil
Technology

NVIDIA Corp

6.66 1.0 Bil
Technology

Amazon.com Inc

4.28 653.5 Mil
Consumer Cyclical

Alphabet Inc Class C

4.24 647.2 Mil
Communication Services

Meta Platforms Inc Class A

3.72 568.0 Mil
Communication Services

Broadcom Inc

3.29 502.7 Mil
Technology

Tesla Inc

2.35 358.5 Mil
Consumer Cyclical

Ndx_14

1.85 282.0 Mil
Corporate

Ndx_11

1.83 279.8 Mil
Corporate