QYLD Vs. JEPI: Which One Is The More Attractive Covered-Call ETF?

Thesis

The World X NASDAQ 100 Lined Name ETF (NASDAQ:QYLD) and JPMorgan Fairness Premium Earnings ETF (NYSEARCA:JEPI) are two standard funds based mostly on the covered-call technique. To wit, QYLD is at the moment yielding (on a TTM foundation) 14.61%, and JEPI is yielding 9.38%. Such ranges of yields aren’t solely extraordinarily interesting in absolute phrases throughout an total low-yield setting (10-year treasury yields lower than 3% and the S&P 500 yield lower than 1.5%), however they’re additionally extraordinarily enticing even when measured by different yardsticks.

For instance, let’s evaluate them to high-yield company bonds. As of this writing, Moody’s Seasoned BAA Company Bond Yield is yielding about 5.1%, solely about 1/3 of the yield from QYLD and about ½ of the yield from JEPI. From one other perspective, let’s evaluate their present dividend yield to their very own historic report. The common yield prior to now 4 years for QYLD has been 11.70% and 6.10% for JEPI. In consequence, QYLD is at the moment yielding a whopping 25% above its historic common, and JEPI much more, about 53% above its historic common. And at last, when in comparison with the surging inflation that’s on everybody investor’s thoughts, their yields are additionally very aggressive (as to be elaborated on a bit later). Nonetheless, buyers mustn’t merely base their determination on the above reductions indicated by the dividend yields. My view is that the comparatively temporary historical past of JEPI has not established a consultant common but.

Apart from the equally mouthwatering dividend yields, there are variations between these two funds. And it’s the focus of this text to intently look at these variations so buyers could make an knowledgeable alternative to suit their private threat profiles and targets. And additionally, you will see why these variations make us favor QYLD greater than JEPI.

QYLD and JEPI: primary data

Simply in case some readers aren’t conversant in these funds but, the next chart reveals an outline of their primary traits. JEPI is a a lot bigger fund with $11.5 billion AUM than QYLD (with about $7.1 billion AUM). When it comes to bills, JEPI expenses a decrease expense ratio of 0.35%, and QYLD expenses a barely larger expense ratio of 0.60%.

The extra elementary variations are of their indexing technique. They observe completely completely different index methods. General, QYLD is listed based mostly on the Nasdaq 100 Index (“NDX”), and JEPI follows a extra value-oriented method as detailed within the fund description under (abridged and emphases added by me). In consequence, the holdings in JEPI are likely to have decrease valuation multiples. As you may see from the desk under, the PE ratio for JEPI is about 21.5x whereas that for QYLD is about 22.5x, a distinction of about 5%. The distinction is extra dramatic when it comes to the price-to-book worth ratio. JEPI’s worth/guide a number of is about 4.0x, in comparison with 6.1x for QYLD, a reduction of greater than 1/3.

Within the the rest of this text, we’ll element the implications of such indexing variations.

In managing the fairness portion of the Fund’s portfolio the adviser employs a three-step course of that mixes analysis, valuation and inventory choice. The analysis findings permit the adviser to rank corporations based on what it believes to be their relative worth… The Fund buys and sells securities in accordance… utilizing the analysis and valuation rankings as a foundation. Usually, the adviser selects securities which can be recognized as enticing and considers promoting them after they seem much less enticing.

QYLD and JEPI: dividend yield comparability

After the above introduction, let’s deal with the elephant within the room first: their dividends. Certainly, many buyers are drawn to those covered-call funds due to their month-to-month and excessive dividend yields.

The subsequent chart summarizes the dividend yields of QYLD and JEPI. The dividend yield for QYLD has fluctuated in a spread between about 9.5% and 13.1% prior to now few years with a median of 11.3%. Its present yield is about 11.8% when it comes to the so-called distribution yield (when the present month-to-month dividend is annualized), barely above its historic common. However when it comes to the TTM yield (which I depend on extra as a result of it filters out the month-to-month noises), it’s yielding 14.6%, greater than 25% above its historic common.

The dividend yield for JEPI has fluctuated in a spread between about 6.59% and 9.6% since its inception in 2021. And its common has been 7.75% since then. And its present yield is about 9.38% each when it comes to the distribution yield and the TTM yield. In consequence, its present yield is greater than 50% above its historic common.

Nonetheless, buyers mustn’t merely base their determination on the above reductions indicated by the yields, because the comparatively temporary historical past of JEPI doesn’t present a consultant common in my view but, as mentioned subsequent.

Thankfully, JPMorgan has one other fund (a mutual fund) that follows a really comparable technique as JEPI: the JPMorgan Fairness Premium Earnings Fund Class A A (JEPAX). JEPAX was launched again in 2019, thus offering about 3 years of historic information. And as you may see from the next chart, the dividend yield for JEPAX has fluctuated in a spread between about 7.08% and 12.1% prior to now 3 years, a a lot wider vary than JEPI due to the longer time period and number of market circumstances. Additionally, the common dividend yield has been 9.31%, a lot larger than JEPI’s imply of seven.75% throughout its shorter lifespan.

If we belief the extrapolation from JEPAX to JEPI, then JEPI’s present dividend yield of 9.38% is definitely on par with its historic yield and there’s no obvious low cost.

QYLD and JEPI: dividends towards inflation

In fact, regardless of the distinction of their low cost relative to their historic report, each funds present adequate dividends each in absolute and relative phrases, as talked about earlier within the article. Right here, let’s look at their dividends towards inflation, one thing that’s on everybody investor’s thoughts today.

Firstly, the present dividend yields from each QYLD and JEPI are larger than the present rampant inflation already (about 8%). Secondly, I extremely doubt the present stage of inflation will final in the long term. I anticipate inflation to stabilize within the 2% vary in the long term (which is concerning the annual common inflation prior to now decade or so). And each QYLD and JEPI have been offering dividend yields of about 11.3% and 9.3% respectively in the long run as simply mentioned. Lastly, QYLD has additionally demonstrated the power to develop the dividend at a wholesome tempo prior to now. Its dividend development price prior to now 3 years has been 2.61% CAGR, and prior to now 5 years has been 8.27% CAGR, each outpacing the common inflation in the long run. JEPI (or JEPAX) has been round for lengthy sufficient to determine a dependable pattern for dividend development. However I consider in the long term, their dividend development price would outpace the common inflation as properly.

QYLD and JEPI: holdings and use of choices

Now let’s dive in and take a better have a look at their holdings and perceive higher how/why they’ll generate such excessive yield constantly. The key is using lined calls. Within the case of QYLD, it writes lined calls on the NDX index, as detailed within the following fund description (abridged and emphases added by me):

QYLD’s lined name place is created by shopping for (or proudly owning) the shares within the Nasdaq 100 Index (“NDX”) and promoting a month-to-month at-the-money index name choice, which traditionally produces larger yields in durations of volatility.

JEPI follows an analogous technique besides it picks completely different shares (extra value-oriented shares as aforementioned) and makes use of these shares because the underlying to cowl the calls. As detailed within the fund description (abridged and emphases added by me),

With a view to generate earnings, the Fund could make investments as much as 20% of its web property in ELNs… ELNs during which the Fund invests are by-product devices which can be specifically designed to mix the financial traits of the S&P 500 Index and written name choices in a single observe type. The ELNs present recurring money stream to the Fund based mostly on the premiums from the decision choices the ELNs write and are an vital supply of the Fund’s return…

In each circumstances, each funds can gather the premium from the choices, which is the principle mechanism for his or her profitable and constant earnings. A comparability of their high ten holdings as proven under in all probability illustrate all of those vital fund traits very clearly. As you may see, QYLD’s high holdings are precisely the identical as the most important shares within the NDX and are dominated by tech shares. And the one distinction is the NDX choice, the three^rd largest holding. Whereas the holdings in JEPI are completely completely different. And you may simply inform from the highest 10 holdings that they’re extra value-oriented and had little or no publicity to tech shares in any respect. And likewise observe the ten^th place is the lined name place.

Apart from producing a gentle earnings, using choices additionally creates different benefits. The usage of choices may scale back volatility as a result of the earnings can cancel off potential losses from worth deprecation. Moreover, the premium on choices tends to go up when market volatility will increase, thusly offering an additional mechanism to battle towards volatility.

Nonetheless, lined calls aren’t silver bullets they usually do have their drawbacks. And the important thing downside is that in addition they scale back the funds’ potential to totally revenue from worth appreciation, as we’ll see subsequent.

QYLD and JEPI: Historic returns and dangers

The chart under reveals a comparability of QYLD and JEPI’s efficiency since JEPI’s inception in 2021. As you may see, JEPI suffered a small whole lack of 1.05% CAGR since then. Whereas each the JEPI fund and total market posted a optimistic return of 10% and seven.6%, respectively.

Once more, the brief time period within the above comparability just isn’t too consultant. And the following chart makes use of JAPEX as JEIP’s proxy to achieve extra insights.

The chart under reveals a comparability of QYLD and JAPEX’s efficiency since 2019. As you may see, each funds have reported a wholesome whole achieve: 7.5% CAGR for QYLD and 11.3% for JAPEX. Though their whole returns have been lagging the general market (16.8% CAGR) by a large margin, such lagging was brought on by their use of lined calls, which restricted their upward potential.

Last ideas and dangers

In abstract, each QYLD and JEPI use a covered-call technique to generate enticing dividends. And I’m optimistic that they’ll proceed to generate dependable dividends sooner or later that may present excessive present earnings and may fight inflation successfully.

Between the 2 funds, we like QYLD higher below the present circumstances. It’s true that QYLD is at the moment yielding about 25% above its historic common, whereas JEPI is greater than 50% above its historic common. Nonetheless, my view is that the comparatively temporary historical past of JEPI has not established a consultant common but. Utilizing JAPEX as a proxy, JEPI’s present dividend yield is on par with the historic common and gives no obvious margin of security. JEPI (and JAPEX too) has outperformed QYLD prior to now, however I believe going ahead, the present 25% valuation low cost from QYLD offers it a a lot better probability of reversing the pattern.

Lastly, dangers. As aforementioned, using lined calls put a structural restrict on the upward potential. Such restrict is particularly related through the interval of quiet (or quieter volatility) for not less than two causes. First, as talked about above, choice premium tends to lower when volatility decreases. And second, on the similar time, fairness worth appreciation tends to correlate positively with low volatility as detailed in our earlier article. In different phrases, when volatility is excessive, it’s a good suggestion to hunker down when it comes to fairness publicity and vice versa. As you may see from the second chart under, the volatility index has subdued considerably YTD, reducing from the 30+ stage routinely seen on the earlier a part of the 12 months to the present stage of 20.6x. To supply broader context, a volatility of 30 is on the high 93% percentile of historic volatility. Whereas 20 is at about 67% percentile solely.