JPMorgan Equity Premium Income I JEPIX

JPMorgan Equity Premium Income takes a nuanced approach to covered calls that delivers high income while reducing downside risk. This fund’s incremental improvements on a basic covered-call strategy makes it a solid option in the derivative income Morningstar Category, though income from covered calls generally isn’t tax efficient.

This fund owns a defensive stock portfolio that targets stocks from the S&P 500 while systematically selling one-month call options on the index. The fund uses slightly out-of-the-money calls, leaving modest room to capture the index’s upside. Manager Hamilton Reiner staggers the one-month calls into multiple weekly buckets to diversify the expiration date and strike prices. However, he doesn’t directly write these calls for the fund. Instead, he purchases equity-linked notes that provide exposure to the profits on those call options. This simplifies the fund’s tax treatment but precludes it from taking advantage of lower long-term capital gains tax rates. Reiner’s team alleviates counterparty risks on the ELNs by spreading trades across multiple issuers and limiting transactions to global financial institutions that pass its regular risk monitoring. It regularly tests pricing and liquidity on the ELNs to ensure they’re getting the best deal.

In general, covered-call funds have not been the best buy-and-hold investments for investors with a longer time horizon. The stock portfolio’s upside is capped, and the downside remains exposed to significant drawdowns, which will likely erode an investor’s long-term total returns. Even for investors with high income needs, there may be more tax-efficient options available, such as selling investments with long-term capital gains. However, covered-call funds provide a simpler way to outsource this task and can alleviate problems that come with self-implementation.

This strategy’s options income offsets some losses incurred during drawdowns, and higher implied volatility during these periods often translates to higher call premiums and higher income. The stock portfolio is less sensitive to the market’s movements, which lessens the sting. It beat the index significantly during the late-2018 selloff and the 2022 market meltdown. Shorting call options caps the fund’s upside relative to the S&P 500, though the fund still outperformed both the category index and category average since its inception.

It earns a Process Pillar rating of Above Average.

The portfolio has two components: a stock sleeve and an options sleeve. The managers construct the equity sleeve to reduce volatility. They try to capture about 80% of the S&P 500’s fluctuations, or a market beta of 0.8. They leverage earnings forecasts from the broader team of J.P. Morgan analysts to build the stock portfolio. Their quantitative forecasts drive selections and weightings, while their qualitative subject matter expertise helps contextualize sources of equity risk and market events. No sector can account for more than 17.5% of the portfolio and no single position can exceed 1.5%, which prevents any single sector or stock from having an outsize impact.

For the options sleeve, this fund sells out-of-the-money calls on the S&P 500 with one month to expiration. The managers use a fixed delta to determine the strike prices, creating a systematic process while letting the strike prices fluctuate with market conditions. The options’ strike prices tend to increase further out of the money during periods of elevated volatility, typically during market downturns, and when interest rates are high. Historically, this figure has hovered around 2% above the index price. The manager ladders the calls in weekly buckets to alleviate market impact costs of their option trades and diversify the strike price and expiration date.

The fund packages its calls into an ELN instead of directly selling the call options. This structure allows the fund to pass through all the premiums it earns for investors as dividends. Depending on market conditions, peers directly using call options will distribute part of their premiums as capital gains and return of capital, which is not taxable income but reduces an investor’s cost basis in the fund. There is a trade-off between these two approaches. The fund loses the ability to recognize a portion of the premiums as long-term capital gains, whose tax rate is more favorable. However, its higher-than-average payout should compensate for this tax treatment for most investors in lower tax brackets.

The use of ELNs invites additional counterparty risk. The fund invests around 15% of its assets in ELNs, which lands below the 20% regulatory cap. It spreads each trade across four to five issuers and usually has exposure to seven to nine issuers at any given time, or well under its 5% issuer limit. The management team is allowed to transact only with large global financial institutions, typically global systemically important banks. They purchase ELNs from issuers offering the best income through a competitive auction process, which should tame the commissions.

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. The defensive stock sleeve should also dampen the sting during market shocks. However, selling call options caps the strategy’s upside roughly at the strike price of the call plus its premium. This detracts from performance in market rallies or when lower implied volatility suppresses premiums. In addition, the lower-risk stock sleeve might not keep up with the S&P 500 during rallies. This can cause the fund to underperform a traditional covered-call strategy that simply holds S&P 500 stocks in these periods.

This stock portfolio tends to underweight mega-cap names and high-growth sectors relative to the S&P 500 owing to its sector and position limit. It also excludes a sizable number of larger index constituents that it considers too expensive or volatile. Instead, the portfolio allocates to smaller companies with reasonable valuations. So far, the stock portfolio has provided protection in most major downturns since the fund’s 2018 inception while moderately keeping up during rallies.

Stock dividends make up a minimal portion of the fund’s payout as the manager doesn’t specifically target dividend-payers. The fund’s annual yield has hovered between 8% and 12% since inception, partly thanks to recent episodes of heightened volatility and high interest rates that pushed premiums up. Its yield will likely decline as interest rates come down but should continue to be competitive.

The team earns an Above Average People rating.

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. His recent promotion to CIO of the US core equity team adds supervisory responsibilities, but this should not affect the strategy’s systematic process. Two junior portfolio managers help Reiner implement the options overlay and act as his backup. The managers also leverage a deep bench of operational resources and the institutional risk framework at J.P. Morgan.

Raffaele Zingone runs the stock sleeve on this fund, leveraging three-plus decades of stock investing experience. The stock portfolio is a clone of a J.P. Morgan managed volatility portfolio that he has managed since 2011 with positive results. Zingone utilizes quantitative forecasts and qualitative industry knowledge from J.P. Morgan’s broad roster of over 20 equity analysts, who average more than two decades of industry experience. The analyst team experienced some turnover in the past few years but has since stabilized. Reiner and Zingone both invest more than $1 million alongside investors in both the ETF and mutual vehicles combined, signaling a strong alignment of interest between management and shareholders.

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.

The fund’s capped upside and defensive stock sleeve left it trailing the S&P 500 during market rallies. The I share class on the US fund lagged the index by over 12 percentage points between November 2023 and March 2024.

Nonetheless, it outperformed the index during major downturns. The fund beat the S&P 500 by 5.49 and 14.23 percentage points during 2018’s fourth quarter selloff and the 2022 market meltdown, respectively. On top of the buffer provided by its call premiums, the fund’s defensive stock portfolio also cushioned large drops. For instance, the stock sleeve outpaced the index by 10.88 percentage points in 2022, an impressive feat even after accounting for its lower exposure to the market’s risk.

The fund also provided better downside protection than its average category peer and the CBOE S&P 500 BuyWrite Index category benchmark. The I share class outpaced the category average and index by 3.4 and 4.6 percentage points, respectively, during 2022’s market meltdown. While the recent market rally has shaved off some of its outperformance, its since-inception returns are still solid. The I share class outpaced the category average and index by over 2 and 4 percentage points annualized, respectively, from its September 2018 inception through August 2024.

Based on our assessment of the fund’s People, Process, and Parent Pillars in the context of these expenses, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Medalist Rating of Bronze.