By Ian Salisbury

Investors can't get enough of covered-call funds, which offer a way to stay invested in stocks without enduring all of the market's gut-wrenching ups and downs. Recent events show that the funds largely deliver on that promise -- though it comes at a heavy price in terms of missed returns.

Covered-call funds own a portfolio of stocks, then sell out-of-the money call options -- those with a strike price higher than the market price of the underlying stock -- on those stocks to collect premium income.

The income stream gives these funds hefty yields and can offset some losses when stock prices decline. The downside is that when stocks zoom ahead, profits can be capped -- as call options give buyers the right to buy the underlying stocks at a set price for a certain period.

Those trade-offs have proved attractive. So far this year, investors have poured a net $3.9 billion into the JPMorgan Equity Premium Income exchange-traded fund, often called by its ticker symbol JEPI. The $40 billion fund, which is the largest active ETF, owns a portfolio of large-cap U.S. stocks and sells S&P 500 call options. JEPI currently boasts an eye-popping annualized yield of 11%.

That figure, based on a Securities and Exchange Commission--mandated formula that looks at a recent 30-day period of income, is temporarily elevated in part because tariff-related market volatility increased the value of the call-option premiums it sold over the past several weeks.

A sister fund, the JPMorgan Nasdaq Equity Premium Income ETF $(JEPQ.UK)$, which targets Nasdaq 100 tech stocks, has grabbed $6.1 billion in net new investment dollars in 2025. With $25 billion in assets, it's the fourth-largest active ETF. Its annualized yield is even more striking, at more than 15%.

All the same, recent events -- particularly the stock market's wild April -- show just how steep a price investors pay for outsize payouts and smoothed investment returns.

The market's wild ride began on April 2 -- "Liberation Day" -- when the Trump administration spooked investors with stiff new tariffs against dozens of countries. The S&P 500 plunged more than 10% in less than a week. The snapback was almost as swift. After hitting bottom on April 8, the index rallied nearly 14% over the next month, essentially erasing its losses, and has continued to advance since.

How did covered-call funds perform? The volatility-calming mechanism worked as advertised, with the funds declining less than the market in the days following the initial tariff announcement -- but afterward, they lagged behind and missed a big part of the recent upswing. JEPI declined 10.3% between April 2 and April 8, when the market bottomed. During the same span, the S&P 500 tumbled 12.1%.

Since then, however, the tables have turned. The S&P 500 has gained 20% from its market bottom through Friday, compared with just 11% for JEPI.

"We tell our clients we're going to have a lot less volatility -- JEPI has about two-thirds the volatility of the market," says portfolio co-manager Hamilton Reiner. "But when the market rips, we aren't going to keep up, because we're taking the income today in return for the upside."

That's fair enough, but it's worth taking a step back to look at just what investors sacrificed to enjoy that smoother ride. An investor in a plain-vanilla stock fund, such as an S&P 500 index fund, who simply ignored or slept through April's volatility, Rip Van Winkle style, would have enjoyed a return of 5.2% from April 2 to May 16. A JEPI investor would still be underwater, with a loss of about 0.5%.

The covered-call sales pitch is so attractive that the funds are likely to continue drawing fans, says Aniket Ullal, head of ETF research at CFRA, noting they have tended to attract inflows in both up and down stock markets. Still, he adds, investors should consider alternatives, including funds that target dividend-paying and low-volatility stocks. "There's a range of strategies that can be adopted to manage risk," he says.

The $88 billion Vanguard Dividend Appreciation ETF $(VIG.AU)$, one of the most popular dividend ETFs, declined 10.8% during the market's big selloff between April 2 and April 8, offering not quite as much protection as JEPI. But over the longer span through May 16, which includes the market's dip and rebound, it has managed to keep investors in the black, with a 2.2% gain.

Write to Ian Salisbury at ian.salisbury@barrons.com

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(END) Dow Jones Newswires

May 23, 2025 21:30 ET (01:30 GMT)

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