ETF Edge - Topping the Charts in 2022 – JPMorgan’s JEPI ETF 1/9/23

Episode Date: January 9, 2023

CNBC’s Bob Pisani spoke with Hamilton Reiner, Head of U.S. Equity Derivatives at J.P. Morgan Asset Management, and Dave Nadig, Financial Futurist at Vetta-Fi. They discussed what sector plays worked well in 2022 and what investors should consider betting on in 2023. Plus, the man who runs one of the most successful active funds out there – the J-P Morgan Equity Premium Income ETF (ticker JEPI) – offers his take on whether actively managed funds can still shine in the year ahead. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

And welcome to ETF, Edge, your go-to place for everything exchange traded funds. I'm your host, Bob Pazani. ETFs continue to rake in money in 2022. But aside from the usual inflows into plain vanilla index ETF, some actively managed funds attracted big inflows. Let's talk to the man who runs one of the 2022's most successful ETFs. Hamilton-Riner runs the JP Morgan Equity Premium Income ETF, the symbol of JEPI. Also joining us, my old pal Dave Nodig, financial futurist for VETify, coolest title.

in the big leagues. Hamilton, this was one of the big, big years for active management. And you had one of the biggest ones out there, 16 billion, 17 billion assets under management. I want to assume everyone knows what JEPI is about. Explain it. You buy low volatility stocks with a little bit of a kicker. Explain what you own. This is really classic active management. Absolutely. It's very active, Bob. So when you think about what we do is we look for 90 to 120 names, stocks that are fundamentally attractive, but also have less earnings variability. So it's going to be much more of a higher quality portfolio. And then around that, we will actually sell out of the money S&P 500 index options.

The options create income and the options also lower volatility in beta associated with the portfolio. So it is active. And it's low volatility, primarily. I mean, I'm looking at the list of biggest holdings, AbbVee, Progressive, United Health, Coca-Cola. It doesn't get more low-volvell than the national. They're blue chip. The types of names that you'd own regardless. Absolutely. Those are the types of names that you would own with or without in options overlay. Those are the types of names that if somebody were to give them to you as part of inheritance, you'd be like, I'm never selling them. Dave, Active Management had one of the best years in many, many years. We all make a joke. Active Manager never outperforms. This year, what we were talking earlier, 60% of them managed to beat their bogeys. What was it about 2022 that was so great for active? We saw a huge dispersion amongst stocks, right? I mean, we all know. some stocks that are down 50 or 60% last year. We also know some stocks that actually traded up last year.

So that dispersion gives guys like Hamilton a real opportunity to find quality outside of all the froth that we had in sort of the run-up in some of these stocks. But Hamilton, I'd love to ask you, you know, as an active manager, you're not just picking the stocks. You're also picking which ones you're clipping a dividend end on, which ones you're going to sell some call options on so that you can get some income. How do you make that determination between, well, this is a keeper for the dividend end, and this one we're willing to sell some upside to get some income. Sure.

So, as I said, we're going to start with that 90 to 120 names, and they're all going to be fundamentally attractive. Whether they pay a dividend or not. As a matter of fact, dividends do you know what I mean coming to our stock selection process? You know, Google's a top 15 holding. About 10% of the portfolio does not pay a dividend. Why? Because when the tide goes out and the market goes down,

you want to own good names, regardless if you do options or not. But then there's the other part. I just got done telling you that we look for those stocks that we find most attractively priced. The last thing I want to do is, is ever give up any of the upsides associated with those names. So we sell options at the index level. So we reduce the bait of our portfolio, but never lose any of those wonderful stocks that Bob just highlighted. By doing that, you always get to keep your stocks. You never have your stocks taken away from you. So you minimize regret, effectively. You never have that thing where it's like, oh, it's up

20 percent, but I cap myself out at five. Right. I'm okay capping the market. I don't want to have my favorite stocks taken away from me. We spent too much time looking for those favorite stocks. The last thing you want to do is have them taken away from you. I want to put up, we just put up a comparison chart of JEPI, which you manage, versus the S&P 500. And this is one of those instances, see here, where it looks like JEPI only modestly outperformed. But because of the payouts that you have and your dividend, it actually was significant when you actually include that. And can you explain why this is not really telling the complete story? Absolutely. You know, this strategy is designed to give our investors 7 to 9% to 3% distributable income.

last year was 11 in change. So last year with the market down, I think it was down around 18 and change, we were down only 3.5%. Because you think about total return. That picture that you see in front of you is the price return. But you have to add back the dividends. So it looks like you outperformed by about four percentage points, but you had an 11% dividend that you put in here.

If you include the S&Ps, 1.5%. You had a 10% spread there just in the dividend. So 10 plus 4 is about 14%. That's how to put in here. how you got this 14% outperformance. It's important for people to understand this. This is one of these circumstances you cannot just look at price outperformance. Well, I mean, in general, investors should always be looking at total return. Where this distinction between income and capital growth comes in is when you're starting to think about taxes or you're starting to think about

actually using that income. If you're in retirement or if you have a liability that you need to match with an income stream, that's where a strategy like this can really pay off, pardon the pun. Yeah, and so where does this fit in, Hamilton, with the passive strategy? I mean, JP Morgan has passive indexes you can buy into two. In the sense, you compete, that your active management competes against the passive strategy. Where does this fit in? When you talk to investors, when they say, well, you know, we're passive investors, but you're doing well, tell us where it fits in. Sure, it goes back to that price return and toll return as well, because when I think about this,

strategy. It is a conservative equity. We're going to have 35% less volatility and baited in the market. And then we're going to give you a multi-prong approach to return, some dividends, some options premium, and then some of the upside. So we're seeing people use that as a conservative equity in their portfolio. We're also seeing people use it as anchor-tended to an income model. As David just said, you have people that just want and need income. It's not easy to find. Even today, if you are looking for income, you're still going to incur a fair amount of credit risk, and duration risk. And so if we can actually be an anchor tenant to a client's income portfolio, it actually really moves the needle. And then we actually see people using as replacement for

extended credit because high yield and emerging market debt may sit in a fixed income bucket, but they got a heck of a lot of equity market beta. So it's like kind of like the feel good ETF, right? I'm still in the market, but I own low volatility stuff. I'm getting some income. I'll give up some upside, maybe, but I feel good. I'm still in it. And that's challenging when you think about active management because active is really about trust. We were talking earlier, nobody's going to tell you what happens tomorrow and if they do their line because nobody really knows, right? So active management is an act of trust and it's important when you start doing something like an options overlay where every day the math about whether an option is a good deal or a bad

deal changes, you need somebody who's really paying attention to that. We've seen a lot of passive strategies that try to do similar types of things. At the end of the day, people tend to come back to active managers, when you're talking about a multi-asset class approach here, where I consider options and asset class all by themselves. Absolutely. But still, this is an ETF with a point of view. I mean, this kind of ETF, this strategy, is bought by people who believe high volatility will continue, and the market won't rally too much so the costs, you know, expire, and

low volatility will continue to outperform. It is a point of view, and that could change very easily. Sure, but there's a couple things I would say. The first thing is quality never goes out of favor. I mean, sort of like L-L bean boots, right? It's one of those things that forever, you never really feel poorly about owning a high-quality portfolio of names. The second thing is income always is a nice kicker to a person's portfolio. And given where we are today, and we've spent a little time before talking about this,

people are underinvested in the equity market. So if we can get them back into the market with those type of names that we own, throw some options on top of that, give them a decent amount of yield, enables them to wade back into the market to actually put some of that money that's on the sideline back to work. So the upside of the strategy is you get income out of the market beyond dividends. The downside is you do give up the upside because you're selling calls, right? That's the risk here. You're going to underperform if the market moves dramatically to the upside.

Absolutely. There is no free lunch. The tradeoff for getting that bird in the hand of income today is at some point you may forego some of the upside. Let's talk about whether people are underinvested or not. We saw an enormous amount, a shocking. inflows last year, $600 billion, I think, and a trillion dollars, almost in outflows of mutual funds? On the mutual fund side, right? And this year will probably, my bar bet is we're going to cross a trillion dollars in flows this year. It seems to be in the cards. There's so much opportunity

for people who are trying to catch a bottom here. There's so much use now of ETFs in the fixed income and almost the cash-like part of the business that I think it's almost inevitable that we cross that number. But we look at the numbers and we do know that people are chronically underinvested right now. It's not that people sold the cash and went away. They've been. moved into bonds, they've moved more defensively into their portfolios. We've even seen a lot more research in gold lately. So that is sort of a risk-off move. How do you manage being chronically under-invested? You come back in tentatively. And being a little defensive in your equity allocation is a great way to start. Yeah, that makes... So the soft landing crowd, we all sound,

you know, nice and glowing here because the soft landing crowd is back in favor in the last couple of days. So everyone's, oh, well, we're all underinvested, right? Here. But we don't don't know if that's going to happen or not. The fact is we're really not sure what. The hope here is for moderating wage growth, folks. That's the soft landing with jobs relatively strong. That's soft landing. But the market's fickle. So I know you're not the strategist for J.P. Morgan, but what's your market prognostication for 2023? I think for the decade between 2011 and 2021, it was remarkable. We had 12% returns, and we had 12% volatility, a ratio of one. Pretty unprecedented. Long term, that average is about 0.4.5. I think we're actually going to have more

volatility this year. I think we're in about 20% VIX, 20% realized volatility. But on top of that, you're going to have 8% to 10% returns. And I think it's just going to be a bumpier road, but equities are going to be positive. And I'm a math person. 8% to 10% total returns. Because that's about the average. Right. So I think we're going back to average. But people right now, if you were to look at all the traditional strategies on the street from the big wirehouses, what have you, they all have the market up three to five percent. I mean, there's this entire, you know, wall of worry that everyone says that you have to wait for capitulation from the retail investor. I think we've really

seen the capitulation from the sell-side strategist. Well, so, but what do you think about what's going on in the earning space? We saw some numbers today, Lulu Lemon in particular, where we've got sort of margin compression happening. That's sort of one of the moving parts in the soft landing story, right? Because if we manage to keep everything alive by just compression corporate margins, that may be fine for the economy, but still pretty bad for stocks. So how do you navigate that? Because income is something you pay attention to. Sure.

When you think about where earnings are, they're probably still a little bit too high, but I don't think anyone is surprised by that. It's when you get these unintended situations, like a couple months back, some of the larger retailers pre-announced negative or come out with some horrible numbers, and the market really put them in the penalty box down 15 or 20% over a very short period of time. I think most people, if you ask them, are expecting a recession,

so no one's going to be shocked if we have one. I think most people are expecting earnings to come down, so no one will be shocked by that. So a lot of this is priced into the marketplace. And if you actually look, oftentimes the market bottoms before unemployment peaks, before earnings, trough. And so a lot of this, I think, is priced in the marketplace. And as we said before, people are off-sized. There's a natural bid to the market. Everyone's waiting to buy the dip.

And when that happens, it ends up being the opposite or pieces start chasing the market. Well, look what's happening already. I mean, just assuming this happens, this sort of. of soft landing scenario. What does it mean for the ETF space? Already, just in the last few days, you can see the growth stocks, Rale, Intel's up 12% this year. Yeah. No, I think the sell is in. Salesforce is up 12%. The sell is already in. I mean, the thing that scares me most about the market right now is how consistent the consensus is. You know, I went through and did that survey at the end of the year of the 20-year-30 Wall Street outlooks for 23, almost universal that we're

going to have a recession. The only question is it, first half or second half, and how hard is it? But if everybody thinks we have a recession, that actually makes me fairly bullish on the market. As am I? And you're not in the, you know, the consensus is it's going to be a rough first half and the second half is where we're going to make money? I think it's relatively unknowable. I think we do have a string of earnings here that I think are going to be a little bit surprising. The sales numbers we've seen, the consumer spending numbers are not like off the charts. We haven't really seen a labor contraction that's really hit core good spending.

That's the thing that I think would really scare people. We really saw a labor-driven recession, but I don't think anybody's thinking about that. I think labor's still really tight. Wages are still really strong. Active management, big winner in 2022. Dividend strategies, big winner. Huge winner in 2022. Is that going to continue?

I think we've seen some of the interest in dividends come off and the VETIFI behavioral data we look at. For December, we saw advisors starting to look a little more conservatively. We saw things like lists of gold funds, list of investment-grade credit funds. Those started to get a lot of interest. That tends to be a bit of a leading indicator. That means to me that we've got a little bit of tentative positioning here at the beginning from the advisor community. That's at the expense of this hunt for income, which saw funds like Jepi and competitors really have a phenomenal year.

So I don't think the bet's off, but I think it's going to slow down a little bit here in the first half. This seems like it's moving very fast. The soft landing crowd is all of a two-day run here. And all of a sudden, you know, you can just see there, it's a coiled spring. There's much more. the risk is to the upside more than to the downside. Yeah, I wouldn't want to be short this market. Moves the market more than small downside news would be more.

I wouldn't want to be short this market right now. And not because I think it will go straight up, but because it's going to have some ripper days. Dave, you've got some news here. You're the financial futurist at Vettify. Your company had an announcement today. TMX group in Canada has become an investor in Vettify. They've got a 21% stake in your company.

What does this mean? Well, so, you know, anytime you get a minority investor showing up like this, you always look for those strategic synergies, strategic synergies. And honestly, if you think about the Toronto Stock Exchange over the years, first ETF, first bond ETS, first options ETFs, first and only Bitcoin ETF for a long time, semi-transparent active, a lot of that stuff comes from Canada first, and then we incorporate it here in the U.S. I'm really excited to be partnering with an organization that's got that kind of innovation behind it. Obviously, it's great for our firm in terms of financial stability.

It's great to have more investors. but really, I'm excited with this opportunity to work with the innovation group. So they own the Toronto Stock Exchange. You know that. Of course, they own a huge suite of other products up there. And you guys own global indices. And, of course, I know you as an ETF services business primarily. So paint a picture.

How does this all interact? Is it just about data services and things like that? What's the synergy? The core thing, if you think about both businesses, is we're customer-centric, but our customers include both investors and folks bringing new businesses. securities to market issuers, fund issuers, guys like JPMorgan, right? So we're serving both of those markets, but we're doing it with a data-driven approach. We're really focusing on analytics and making sure that we're getting the right products to the right investors. You can say that

about VETify, you can say that about TMX, you can almost just like cut and paste. We really are focused on the same way of doing business and serving very similar markets. And of course, I'll look forward to seeing you at the Exchange ETF Conference, which you are the primary sponsor. February 5th, Miami, at the Fountain Blue. You're going to be there too. I will be there as well. Talking about JEPI as well. Thank you, everybody. My thanks to Hamilton and the Dave, and thanks to you for watching. This is our 50 year we're going into with ETF Edge, and it's our first show of the new year. In coming weeks, we'll bring you all the big players in the ETF space and how investors are using ETFs to build out portfolios.

We'll show you how they are using ETS and how you can use them as well. I promise you that more in That's all coming up on ETF Edge this year, including, of course, the ETF conference that Dave is doing in Miami. That'll be in first week of February. Remember, you can see all of our shows and tune into our podcast as well on the website, etfedge.c.com. Everybody have a healthy, happy and safe trading week. Get the ABCs of ETFs with the ETF Edge newsletter.

Your weekly update on the hottest trends, expert analysis, actionable ideas, and exclusive insight from host Bob Pisani. Sign up now at cnbc.com forward slash etf edge newsletter.