JEPQ: This Could Be An Interesting Time To Add Shares Of This 9 … – Seeking Alpha

In 2022, I became a fan of the JPMorgan Equity Premium Income ETF (JEPI) due to its portfolio composition, investment strategy, and dividend yield. Being optimistic for 2023, I have been looking at ETFs that generate a substantial yield while having the ability to benefit if the market rebounds. I can allocate capital toward a 1-year CD and get a 4.3% APY from Marcus by Goldman Sachs (GS) risk-free, so when it comes to income investments, I am trying to exceed the 6-7% level for taking on risk. As lower commodity pricing works its way through the system, inflation could continue to decline, which may result in a Fed pivot later in 2023. If this occurs, there is a substantial chance that the market will enter into a recovery phase. The JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ:JEPQ) is an interesting fund that provides a 9% yield and is positioned to capture upside appreciation if the market turns. Based on what’s occurring in the macro, I am becoming more interested in this ETF as it is structured to deliver a significant portion of returns associated with the Nasdaq 100 with less volatility.

How JEPQ is structured to capture capital appreciation and generate monthly income

JEPQ has a similar approach to its investment strategy as JEPI. JEPQ invests in equities found within the Nasdaq 100 and creates an actively managed portfolio while selling call options through equity-linked notes (ELNs) to generate income. JEPQ’s investment objectives of generating income while capturing upside opportunity when the market appreciates is derived from this strategy. JEPI invests at least 80% of its assets in equities securities. JEPQ is clear that what they consider assets in the 80% are net assets plus the number of borrowings for investment purposes which can be allocated to common stocks, ELNs, and other equity securities. Through this strategy, JEPQ will construct its equity portfolio in a way that is anchored by technology companies or companies that rely heavily on technological advances.

On the income side, JEPQ allows its fund managers to allocate up to 20% of JEPQ’s net assets into ELNs. ELNs are structured as notes that are designed to offer a return linked to the underlying instruments within the ELN. The ELNs that JEPQ invests in are derivative instruments that combine the economic characteristics of the Nasdaq 100 and written call options in a single note form and are not traded on an exchange. The options within the ELN will be correlated to the Nasdaq 100 or an exchange-traded fund that replicates the Nasdaq 100, such as the Invesco QQQ ETF (QQQ). JEPQ looks for ELNs that are structured to use a covered call strategy and have short-call positions embedded within them. When JEPQ purchases an ELN, JEPQ is entitled to the premiums associated with the options which provide recurring cash flow. The ELNs are reset periodically to seek to better opportunities based on market conditions.

JEPQ has some other underlying rules within its investment process. JEPQ will not invest more than 25% of the value of its total assets in the securities of companies conducting their primary business activities in the same industry. In the event that an industry represents more than 20% of the Nasdaq 100, JEPQ may allocate 35% of its total assets to that industry. The fund managers for JEPQ utilize a data science-driven approach to making investment decisions. This entails combining research, data insights, and risk management. The managers define data science as extracting useful insights from collections of information as they analyze and combine a wide variety of data sources, including fundamental research, company fundamentals, and alternative data.

Has JEPQ accomplished one of its investment goals of being less volatile than the Nasdaq 100?

JEPQ’s summary Prospectus indicates that JEPQ is designed to provide investors with performance that captures most of the returns associated with the benchmark while exposing investors to lower volatility than the benchmark and providing incremental income. 2022 wasn’t a good year for the Nasdaq as it closed the year in a bear market. On a percentage basis prior to dividends, JEPQ was more volatile than the QQQ as JEPQ had fallen -14.87% since May 3^rd, 2022, when it was created, compared to -11.53% for the QQQ.

On May 3^rd, JEPQ hit the market at $50 per share, while QQQ traded at $318.82. Today JEPQ closed at $42.58, while QQQ closed at $281.54. Over this period, JEPQ has paid 8 dividends, amounting to $3.85 per share, and QQQ has delivered $1.70 from dividend income across 3 dividends. Without considering the effects of compounding, when the $3.85 of dividend income is factored into the investment, shareholders of JEPQ since May 3^rd, 2022, have seen their overall investment decline -7.14% compared to -11.16% in the QQQ.

As JEPQ is a fairly new ETF, there isn’t even a full year’s worth of data to analyze. Based on the current data, JEPQ has not accomplished its goal of being less volatile than its benchmark without considering dividend income, as QQQ has outperformed it by 3.34%. When dividends are accounted for in both JEPQ and QQQ, JEPQ has outperformed QQQ by 4.02% since its inception.

Breaking down JEPQ’s current portfolio and speculating on how it sets up for 2023

As of 1/13/23, JEPQ had 50.24% of its net assets tied to its top 10 holdings. I downloaded the entire roster of holdings and deconstructed them. JEPQ had 16.43% of its assets tied to ELNs, 1.4% tied to a money market account and 0.13% in cash. This puts 17.83% of its portfolio into investments outside of equities, while 82.17% is invested in 76 individual equities found within the Nasdaq 100.

JEPQ is a very top-heavy fund as 17 of their 76 individual equities make up 50.46% of their entire portfolio. If you believe big tech will lead the way this upcoming earnings season, and carry the market upward, then JEPQ is an interesting ETF. The Big 5 of large-cap tech, which includes Microsoft (MSFT), Apple (AAPL), Alphabet (GOOG) (GOOGL), Amazon (AMZN), and Meta Platforms (META) account for 33.39% of the entire portfolio. When Nvidia Corp (NVDA), Tesla (TSLA), and Cisco Systems (CSCO) are added, these 8 companies make up 39.85% of the portfolio. Outside of the top 8 equity positions, only 10 other companies hold a 1% or higher net asset percentage of JEPQ. The bottom 58 companies account for only 38.08% of the portfolio, all of which have less than 1% of net assets attributed to them. Within the bottom 58 positions, investor favorites such as PayPal (PYPL), Broadcom (AVGO), Netflix (NFLX), Costco (COST), The Coca-Cola Company (KO), and Nike (NKE) can be found.

JEPQ has produced sizable monthly dividends for its shareholders

Since its inception in May of 2022, JEPQ has delivered dividends each month to its shareholders. Its income-producing strategy from the ELNs have generated $3.85 in dividend income. The monthly dividends have ranged from $0.34 to $0.68 per share for an average monthly dividend of $0.48 per share. If this trend continues, JEPQ will generate $5.78 per share of dividend income on an annualized basis. Based on today’s share price, that would be a 13.57% yield.

While JEPQ hasn’t been around long enough to establish a multi-year track record, its current methodology of utilizing ELNs to produce income has paid off for investors. There is no reason to believe that this sequence of monthly dividends won’t extrapolate into an ongoing sequence over the next several years. JEPQ is well on its way to establishing a long-term track record of paying monthly dividends.

Conclusion

I am very interested in JEPQ as I believe we are closer to the market turning rather than declining. The Nasdaq is still in a bear market, looking at a 1-year chart, and the Nasdaq has fallen 3,934.88 (-25.44%) since its high of 15,446.29. My personal belief is that for the market to reach new highs, big tech will need to play a critical role in the recovery. I don’t see companies outside of big tech being able to add hundreds of billions to their market caps or generate the amount of growth needed across revenue and net income to drive the market higher. For this reason, JEPQ is very interesting because its upside potential isn’t capped by covered calls against its position, and it’s very top-heavy in companies such as MSFT, AAPL, GOOG, AMZN, and META. JEPQ is a way to generate significant capital appreciation if the market turns without capping the gains to generate current income. Even if the market gets back to its highs, JEPQ would still offer an attractive yield that is paid monthly. As earnings season is around the corner, I will be looking to start a position prior to big tech earnings kicking off and possibly adding to it if there is another leg down in February.