The Most Dangerous Dividend ETF Investors Keep Buying

The JPMorgan Equity Premium Income ETF (NYSEMKT: JEPI) has become a $44 billion giant and the largest in the covered call ETF category. The fund is a relatively easy sell for income seekers too -- a low-volatility, large-cap portfolio with an 8% yield that's paid monthly. It seems to keep drawing in money regardless of its performance.

It became a Wall Street darling in 2022, when it outperformed the S&P 500 (SNPINDEX: ^GSPC) by 15 percentage points and routinely offered double-digit yields. But lately, it's been riding on its reputation.

Since the beginning of 2023, the JPMorgan Equity Premium Income ETF has returned 34%, which significantly lags the 99% return of the Vanguard S&P 500 ETF (NYSEMKT: VOO) over the same time. A covered call ETF isn't likely to, or expected to, beat the U.S. stock market in a bullish rally.

But the amount of money that continues to flow into the fund suggests that investors might need a refresher on what they own -- and why a repeat of 2022 may not be coming.

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What JEPI actually is

This isn't a dividend stock ETF in the same vein as the Schwab U.S. Dividend Equity ETF. It invests in low-volatility (but not necessarily dividend-paying) stocks selected using a fundamental research process. To generate the income, it writes call options on the S&P 500 and distributes that to shareholders.

That means investors are receiving mostly options premiums, not dividends, in their accounts. That's an important distinction because it means that income levels are driven by volatility, not corporate performance. As volatility rises, option premiums tend to rise, and vice versa. Part of the reason that the JPMorgan Equity Premium Income ETF's yield is lower today than it was in 2022 is because stocks aren't bouncing around today like they were then.

The bigger issue is the risk/reward profile and the path of returns for this fund. In the end, it's a covered call ETF, which means it sacrifices upside capital growth potential in exchange for that yield.

In an up-trending market, its share price gains are capped by the options, but some of that underperformance can be offset by the higher yield. In a down-trending market, the fund will generally experience all the downside, but could outperform its underlying benchmark because of the higher yield.

Who JEPI is for

This ETF is for conservative investors who are prioritizing income.

There's nothing wrong with the covered call ETF structure, as long as you know what you're getting. Income seekers may be fine capturing the yield at the expense of share price growth if they're living off their portfolios. The JPMorgan Equity Premium Income ETF's use of low-volatility stocks and S&P 500 call options is actually one of the better versions of the structure. You just need to understand how the fund will perform in different environments.

Who JEPI isn't for

JEPI isn't for investors who are trying to beat the S&P 500.

2022 was a best-case scenario where the S&P 500 decline was steady, but overall volatility remained relatively contained. That showed in returns.

But the market tends to go up more often than it goes down. That means JEPI is likely to lag the S&P 500 more often than it doesn't. It's not really a fair comparison anyway, since the goal of covered call ETFs isn't to outperform stocks over the long term.

I believe that many investors in this fund remember 2022 well, but have discounted what's happened over the past few years. JEPI can still do very well in the right type of environment. But anyone expecting a regular repeat of that year will probably be disappointed.

David Dierking has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.