The strong stock market rally at the end of this year may have drawn away some of the interest in funds that use options to generate income, but Wall Street asset managers are betting that the category’s future is still bright. The face of the sector is the JPMorgan Premium Income ETF (JEPI) . JEPI has seen inflows of nearly $13 billion this year, the most of any active ETF in the U.S., according to FactSet, but those inflows slowed to a trickle in the final weeks of the year. Part of the reason for the slowdown could be that income funds are less attractive in a market rally, as opposed to the downturn of 2022. Through Dec. 20, JEPI had a total return of 8.7% year to date, compared to 24.3% for the SPDR S & P 500 ETF Trust (SPY) . The JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) has seen more inflows recently than JEPI but has likewise underperformed the Nasdaq-100 index. The underperformance during rallies is to be expected from covered call funds, which trade off potential future upside for income today. Bryon Lake, global head of ETF Solutions at JPMorgan Asset Management, said there was a “mismatch” between investor expectations early this year and what the market actually did, so he doesn’t think investors should be disappointed with the performance of the funds. “The scenarios when [these funds] are going to struggle is straight up markets. And what I think investors were willing to do this year is, they were much more worried about the downside, so to take some of that off the table and still participate and get a positive return in that environment, was absolutely the trade that they wanted,” Lake said. “And I think in hindsight if you said that based on what you knew coming into the year, are you happy with what you did? And I think to a person they would say yeah, absolutely.” Even with this year’s relative underperformance, Lake said he still thinks income-focused funds like JEPI should see “relatively evergreen,” consistent demand because people never expect massive rallies for stocks to continue. Other issuers are also betting that the options income craze will prove more than a passing fad. There have been several JEPI competitors launched this year, including the Goldman Sachs S & P 500 Core Premium Income ETF (GPIX) and the Parametric Equity Premium Income ETF (PAPI) . The Global X S & P 500 Covered Call ETF (XYLD) actually predates JEPI. The rival funds have aspects that distinguish them from the market leader — GPIX uses an index approach to its stock holdings, while JEPI has active stock picking, for example — but all have similar, general structures. Meanwhile, buffer ETFs have continued to proliferate. Those funds, also called defined outcome products, offer explicit downside protection instead of high income, but similarly appeal to more risk averse investors. What Comes Next John Hooson, managing director for Brown Brothers Harriman’s Global ETF product team, told CNBC he expects more defined outcome funds to come to market in 2024, as well as option income funds such as those using covered call strategies. “You continue to see sponsors innovate and come up with different takes or slants. … As a concept, I think you’ll see them continue to grow,” Hooson said. One type of innovation could come through the precise type of options used. Asset manager Defiance is trying to couple the interest in zero-day to expiration options with the desire for income in the Nasdaq-100 Enhanced Options Income ETF (QQQY) , which it launched in September. And last week, ProShares launched the S & P 500 High Income ETF (ISPY) , which attempts to generate the income of the S & P 500 Daily Covered Call Index through swaps. Simeon Hyman, head of the investment strategy group at ProShares, said that he thinks the short rollover period of the ProShares fund can help investors capture more of the upside during market rallies than the larger income funds already on the market. “They’re not hiding it, but I think a lot of investors may have been not quite paying attention until kind of now,” Hyman said of options income funds’ underperformance during market rallies. And even though ISPY was introduced just as flows have started to weaken for some other income products, Hyman said he expects that there is still plenty of demand for options income funds. “We all see the exponential growth of this category, and I don’t think that’s going away. If anything, the interest rates coming back down are going to cause people to look for even more opportunities to generate income,” Hyman said.
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