The JPMorgan Nasdaq Equity Premium Income ETF (JEPQ 1.37%) is one of the market's most interesting monthly income-paying exchange-traded funds (ETFs). Its management aims to generate relatively low-volatility returns and a consistent monthly income for investors through a simple strategy that captures the upside from equities but avoids some potential pitfalls of high-yield investing. Here's a look at how this ETF does that and how it can generate serious returns for investors.
$1,000 a month into $232,000 over a decade
The ETF currently has a trailing-12-month rolling dividend yield of 9.9%, and as you can see below, it has a consistent history of paying a good dividend.
JEPQ Dividend data by YCharts
Let's assume an investor starts with $10,000 in the ETF, commits to adding $1,000 monthly, and reinvests the dividends. Furthermore, to keep things simple and conservative, let's assume the ETF's price remains unchanged. At the end of the first year, the investor would have invested an initial $10,000 plus $12,000 in monthly contributions in the ETF and generated about $1,600 in dividends for a total of $23,600.
In the second year, as the magic of compounding kicks in, the investor would have added a further $12,000 and generated $3,000 in dividends by the end of the second year, totaling about $38,600.
The total figure would come to about $232,000 at the end of the decade, and again, that's assuming the ETF's price doesn't change.
Believing in the numbers
It's not difficult to plug some numbers in, but the tricky bit is how the ETF might generate this kind of income for investors consistently. The answer lies in its two-pronged and complementary strategy:
- As much as 80% of the ETFs assets are invested in equities "comprised significantly of those included in the Fund's primary benchmark, the Nasdaq-100" index, JPMorgan says.
- The ETF may invest as much as 20% of its assets in equity-linked notes (ELNs) that sell out of the money call options on the Nasdaq-100 index.
Both parts of the strategy contain some nuance.
Image source: Getty Images.
The equity strategy
While the equity strategy may seem straightforward, note that it's investing in Nasdaq stocks, and dividend yield is not necessarily a factor in its portfolio construction. Indeed, its top holdings include Apple, Microsoft, and Nvidia. As such, this isn't a typical high-yield equity fund that could be loaded up with stocks in one or two high-yielding industries. In addition, it's not full of stocks that pay high dividends but don't grow much because their dividend payments are using up capital that could be invested for growth.
The ELN strategy
The ELN strategy makes this ETF unique and is also the primary way it generates income for investors. Call options on the Nasdaq-100 let the buyer (who pays a premium for the option) buy the index at a fixed price within a specified date. Investors buy them, hoping the index will rise. As such, an investor selling a call option hopes to keep the premium if the index doesn't rise above the strike price.
The ETF invests in ELNs selling call options, generating premiums when the Nasdaq-100 index doesn't rise significantly in a month. On the other hand, the ELN strategy won't do well when the market surges. However, the equity strategy will likely generate strong returns in that scenario.
Image source: Getty Images.
A plan that's hard for investors to replicate
The ETF's strategy allows retail investors to invest in a plan that's hard to replicate. It also provides access to a relatively low-volatility investment strategy aiming to generate monthly income for investors. Those characteristics encourage confidence in investors to invest monthly amounts to generate long-term returns.
