JEPI Is Not The New ARKK

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One twelvemonth agone Jason Zweig wrote an article successful nan Wall Street Journal astir nan ARK Innovation ETF (NYSEARCA:ARKK). Thanks to a stellar performance, ARKK received monolithic inflows of investors chasing that performance. Figure 1 shows ARKK's capacity since nan article was published.

Figure 1: Total return floor plan (Yahoo! Finance, Author)

Recently Zweig wrote different article successful nan Wall Street Journal highlighting nan large inflows into nan JPMorgan Equity Premium Income ETF (NYSEARCA:JEPI) aft it's stellar performance. Is JEPI nan caller ARKK? Will JEPI suffer nan aforesaid destiny arsenic ARKK?

For america nan short reply is clear: no!

Why? The capacity of ARKK is limited connected easy money conditions, while this is not nan lawsuit for JEPI. The second performed very good some successful 2021 and 2022. It performs good some successful a debased and a precocious complaint environment.

The agelong reply you tin find below. We return a look astatine nan beta exposure, nan equity long and nan volatility sensitivity of some ARKK and JEPI.

Beta exposure

Both ARKK and JEPI are agelong equities. But ARKK is precocious beta and JEPI is debased beta.

Covered telephone penning is simply a defensive, low(er) beta, strategy. When nan markets rise, you get a bully return. That return will astir apt little than nan return of nan equity markets itself, but that's thing you cognize successful advance.

When nan equity markets fall, you outperform acknowledgment to nan collected action premiums. Of course, erstwhile nan marketplace really tanks, you will still person a antagonistic return. Another measurement to framework this: nan upside beta is little than nan downside beta.

Let's springiness an stylized example. Suppose we person a banal pinch a value of $100. We constitute a telephone pinch onslaught value $110 and we cod $3 action premium. When nan banal moves to $120, we "get" $13 (or upside is capped astatine $110 positive nan $3 premium), aliases an upside beta of 65%. When nan banal drops 20%, we "get" a consequence of -$17 (a value driblet of $20% positive nan $3 premium), aliases an downside beta of 85%.

An 2014 AQR study showed and upside and downside beta of 0.63 and 0.78 for nan CBOE S&P 500 BuyWrite Index (BXM) for nan play 1986 to 2013.

Figure 2: Covered telephone statistic (AQR)

Despite nan truth that nan downside beta is bigger than nan upside beta, covered telephone strategies are capable to present equity-like returns pinch little volatility.

Regarding ARKK's beta-exposure we tin beryllium short: it's a precocious beta-ETF.

Figure 3: Total return floor plan (Yahoo! Finance, Author)

And ARKK is precocious beta some successful up markets (figure 3) arsenic successful down markets (figure 4).

Figure 4: Total return floor plan (Yahoo! Finance, Author)

When nan backdrop for equities is affirmative (cheap money, debased inflation, debased liking rates) ARKK will outperform. And vice versa, it will underperform.

Equity duration

The past twelvemonth was not bully for equities. The aforesaid tin of people beryllium said of astir equity factors.

Figure 5: Total return floor plan (Yahoo! Finance, Author)

The worst equity facet was growth. Those debased dividend, "long duration" maturation equities were heavy deed by nan rising liking rates. Dividend stocks beryllium connected nan different extremity of nan long spectrum and hence little impacted by nan higher rates.

ARKK is simply a growth-ETF pinch a precocious equity duration, while JEPI is alternatively a dividend ETF pinch a debased equity long and hence little impacted by rising liking rates.

Inflation and longer word treasury yields started to emergence successful 2021 and ARKK started to underperform.

Figure 6: Inflation and liking rates (FRED)

JEPI was little impacted and not only kept gait pinch rising equity markets successful 2021. Last year, equities fell and JEPI outperformed.

Figure 7: Total return floor plan (Yahoo! Finance, Author)

It will beryllium nary astonishment that JEPI is simply a debased long ETF and ARKK a precocious long ETF. If liking rates stay precocious (or emergence moreover further) JEPI will beryllium little negatively impacted than ARKK.

When liking rates autumn and nan autumn is not caused by a recession, this would beryllium bully news for equities successful wide and precocious long stocks successful particular. JEPI would person a affirmative return, though it would astir apt lag nan wide market. ARKK would again beryllium firing connected each cylinders.

When liking rates autumn owed to a recession, it remains to beryllium seen really equity markets will perform.

Short volatility

A covered telephone ETF has really 2 sources of return: nan equity consequence premium and nan volatility consequence premium. They are agelong equities (albeit pinch a debased beta) and short volatility.

Being agelong equity is much straightforward for astir investors compared to being short volatility.

When you waste options, you are short volatility. We tin comparison trading options pinch trading insurance. Just arsenic an security argumentation provides protection against a imaginable early event, an options statement tin supply protection against adverse value movements successful an underlying asset. And successful nan security industry, nan received premiums typically transcend claims connected those contracts. People salary "too much" for their insurance. Likewise they salary excessively overmuch for nan options they are buying. As a consequence they thrust up nan value (and hence nan implied volatility). And erstwhile realized volatility is debased comparative to implied volatility, nan short position is profitable for action sellers for illustration JEPI.

Realized volatility is simply a backward-looking and describes really an plus really performed successful nan past, i.e. nan humanities aliases existent volatility achieved. Implied volatility connected nan different manus is simply a forward-looking estimate of volatility derived from nan value of an action done nan usage of a theoretical pricing exemplary for illustration nan Black & Scholes model.

Option prices bespeak respective factors that are straight observable aliases known specified arsenic nan underlying price, nan clip until expiration, and onslaught price.

Figure 8: Implied volatility (CBOE)

The Black & Scholes look utilizes those observable parameters to cipher nan mean early volatility of nan underlying asset, nan "implied" volatility.

A covered telephone ETF's short position is profitable erstwhile realized volatility is debased comparative to implied volatility and unprofitable erstwhile realized volatility is precocious comparative to implied volatility. Historically, we observe a propensity for nan action marketplace to value successful somewhat much expected volatility than what is subsequently realized (as is nan lawsuit successful nan security business).

ARKK uses nary options and doesn't effort to seizure nan volatility consequence premium, but location is nevertheless a nexus pinch (expected) volatility. The VIX Index is simply a measurement of expected volatility that is derived from prices of options group to expire 30 days successful nan future. Expected and implied volatility are related but unique.

Figure 9: Expected volatility (CBOE)

Generally, nan VIX Index tends to person an inverse narration pinch nan equity markets. This antagonistic relationship has led to nan nickname "fear index" because nan VIX Index has a inclination to move up quickly erstwhile nan wide marketplace falls sharply. Expected volatility typically increases erstwhile markets are turbulent aliases nan system is faltering. In contrast, if banal prices are rising nan VIX Index tends to autumn aliases stay dependable astatine a debased level. In this sense, 1 could telephone ARKK a short volatility investment, that performs good erstwhile expected volatility is debased and vice versa.

Macro backdrop

Both ARKK and JEPI for illustration an situation successful which equities are rising pinch debased volatility.

When equity markets execute strongly, JEPI will person a bully return albeit that it will way nan broader equity market. But that's thing we cognize successful advance. In this benign situation ARKK tin beryllium expected to outperform nan broader market, fixed its precocious beta.

Last year, we had really nan opposite: an situation pinch falling equities and precocious volatility. ARKK performed horrible, while JEPI had a awesome year. That's nan constituent we want to make: JEPI performs good nary matter what nan macro backdrop is.

Figure 10: ARKK vs JEPI (ETFreplay.com)

Will we return to an situation pinch debased volatility aliases is nan higher macro volatility owed to nan precocious ostentation present to stay?

Research Affiliates past twelvemonth investigated really quickly ostentation returns backmost to an acceptable level erstwhile it crossed definite thresholds. They make a quality betwixt cresting ostentation and accelerating inflation. Cresting ostentation crosses nan 4% level, but doesn't scope nan 6% ostentation level. Accelerating ostentation does transverse nan 6% level. The humanities grounds is for illustration this:

If ostentation is cresting, ostentation levels revert by half successful astir a year. If ostentation is accelerating, 6% ostentation reverts to 3% successful a median of astir 7 years. Above 8%, reverting to 3% usually takes 6 to 20 years, pinch a median of complete 10 years.

Figure 11: Years for ostentation to autumn by 50% (Research Affiliates)

We deliberation ostentation is present to stay. It will astir apt cool, but we judge it will stay nan coming years astatine a level supra nan 2% FED-target. De-globalization, de-carbonisation and demographics are pushing ostentation figures higher than we were utilized to successful nan past decade.

JEPI has besides a costs advantage compared to ARKK. ARKK has an disbursal ratio of 0.75%, while JEPI is astatine 0.35%. This costs advantage is coming nary matter what nan macro backdrop.

Equity markets

When nan equity marketplace really tanks, JEPI will person a antagonistic return. That's why we for illustration not to put successful a covered telephone strategy erstwhile nan equity marketplace is successful a agelong word down trend. This is nary longer nan case.

Figure 12: Total return floor plan Figure 12: Total return floor plan (Yahoo! Finance, Author)

When nan LT inclination is intelligibly up, we get a greenish light/colour. Vice versa, erstwhile nan LT inclination is intelligibly down, we spot a reddish light/colour. In betwixt nan colour is orange.

The ribbon successful nan price-part of fig 12 shows nan LT trend-colour, while nan little portion of nan floor plan shows nan ST trend. We near retired nan orangish colouring to debar overloading nan chart.

Likewise, we for illustration not to put successful ARKK erstwhile nan equity marketplace successful wide and exertion stocks successful peculiar are successful a agelong word down trend. You bargain ARKK because you expect it to outperform successful a rising market. Currently nan NASDAQ is nary longer successful a downtrend.

Figure 13: Total return floor plan (Yahoo! Finance, Author)

But trend-wise, nan outlook for precocious div, worth stocks is still amended than nan outlook for maturation stocks, moreover aft nan bully caller performance.

Figure 14: Trends (Yahoo! Finance, Author)

This is besides reflected successful nan agelong word inclination of JEPI (and SPY) versus ARKK and QQQ.

Figure 15: Trends (Yahoo! Finance, Author)

Conclusion

JEPI performs arsenic expected nary matter what nan macro environment. When nan markets rise, JEPI will get a bully return. That return will astir apt beryllium little than nan return of nan equity markets itself, but that's thing we cognize successful advance. When nan equity markets fall, JEPI will outperform acknowledgment to nan collected action premiums. Of course, erstwhile nan marketplace really tanks, JEPI will person a antagonistic return. That's why we for illustration not to put successful specified a strategy erstwhile nan equity marketplace is successful a agelong word down trend. This is nary longer nan case.

We cannot opportunity that ARKK will execute good nary matter what nan environment. ARKK only thrives successful a inexpensive money environment. And that train has near nan station. We expect ostentation to cool, but we do not envisage a return to inexpensive money situation of nan past decade.

We would for illustration to reason pinch a quote from nan AQR study we mentioned before: "Selling covered calls whitethorn beryllium a bully stand-alone strategy erstwhile implied volatilities are precocious comparative to expectations and, successful particular, a bully strategy erstwhile mixed pinch earning nan equity consequence premium."

According to us, JEPI is not nan caller ARKK.

Hi, I’m a backstage investor and a teacher. I for illustration to programme and nan banal markets are a fertile playground for information study and visualisation and this helps maine return well-informed decisions.