Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / How Bull Markets Are Rewriting the Active ETF Playbook
Transcript
- Lucas: The S&P 500 closed today at 7,490, down a hair over the last five days — but we're still up roughly 14 percent on the year. The Russell 2000, the small-cap index, actually gained 0.4 percent over the same period. That's a subtle rotation, and it's happening while a specific corner of the ETF market is exploding in popularity. Luna: You're talking about active ETFs. The semi-transparent ones and the defined-outcome ones. I feel like I can't open my brokerage app without seeing a new one. Lucas: Exactly. And the poster child for this trend is the JPMorgan Equity Premium Income ETF, ticker J-E-P-I. It's now roughly 35 billion dollars in assets. That's enormous for an active ETF. It launched in 2020, and it's basically a covered call strategy on the S&P 500 — they sell out-of-the-money call options every month, collect the premium, and distribute it as income. Luna: Right. So you get a monthly check, but you cap your upside. In a bull market, that feels like leaving money on the table. Lucas: That's the trade-off. JEPI's yield has been around 7 percent annually, but its total return since inception lags the S&P 500 by a decent margin. In 2023, when the S&P rallied 24 percent, JEPI returned about 13 percent. So you're sacrificing roughly half the upside in exchange for smoother, income-heavy returns. Luna: And yet, 35 billion dollars. Who's buying it? Lucas: A lot of retail investors nearing or in retirement. They want the income, and they're willing to give up some capital appreciation. But also — and this is the interesting part — advisors are using it as a core holding in income-focused portfolios. It's become a sort of default option for 'yield without crazy risk.' Luna: But if the market drops hard, does the strategy protect you? Because you're still holding the underlying stocks. The options premium helps, but if we get a 2008-style drawdown, JEPI is going down with everything else. Lucas: That's the key question. The options premium provides a cushion — maybe 2 to 3 percent per month in premium income — but if the market drops 20 percent, the NAV is dropping. It's not a tail-risk hedge. It's more of a volatility smoothing mechanism. In a flat or slowly rising market, it shines. In a crash, it still hurts. Luna: So it's a product built for a specific regime — low volatility, moderate upside. Which is basically the regime we've been in, aside from 2022. Lucas: Right. And that's why active ETFs more broadly are having a moment. According to Morningstar data from last month, active ETFs now account for nearly 8 percent of all ETF assets, up from about 4 percent two years ago. Managers are converting mutual funds into ETFs to capture the tax efficiency and lower costs. The semi-transparent structures allow them to hide their holdings a bit, which was a big concern for stock-pickers. Luna: I want to dig into that — the semi-transparent thing. Because the original pitch for ETFs was full transparency. You know what you own. But the active guys said, 'If we show our hand every day, people will front-run us.' So the SEC allowed these non-transparent structures. Is that a good thing for investors? Lucas: It's a compromise. The investor gets the ETF wrapper — intraday trading, potentially lower taxes, lower fees than a mutual fund — but they don't see the full portfolio daily. Instead, they get a proxy portfolio or a weekly disclosure. For a large-cap active manager, that's probably fine. For a highly concentrated small-cap fund, it might matter more. Luna: And then you have the defined-outcome ETFs, which are a different beast. Those use options to cap both upside and downside over a specific period — usually one year. They're marketed as 'buffered' products. Lucas: Yes. Innovator ETFs basically created that category. They now have dozens of them, with different buffer levels — 10 percent, 15 percent, 30 percent. In this bull market, the ones with a cap have been hit hard because the cap gets breached early and then you're stuck with no upside for the rest of the year. Luna: Right. If the market goes up 14 percent in seven months, and your cap is 12 percent, you're done for the year. That feels bad. Lucas: It does. But the buyers are typically retirees or conservative investors who value the downside protection more than the upside potential. They're willing to trade away the tail to sleep better at night. And that's a valid preference. Luna: So the bull market is creating this interesting tension: the products that are designed to protect you are underperforming the very index they're tied to, and yet money keeps flowing in. Lucas: Exactly. It's a testament to how powerful the behavioral factor is. People want income. They want sleep insurance. They're willing to pay for it, even if it costs them returns in a rally. Luna: And if today's conversation helped you think about your own portfolio choices, that's exactly what we're here for. These shows stay ad-free because of listener support — buy me a coffee dot com slash fexingo. Lucas: Yeah, that's right. It's a small gesture that keeps the lights on and lets us keep digging into topics like this. No pressure, just if you find value in it. Luna: So back to the broader trend — with the Fed holding rates at 3.63 percent, and the S&P near all-time highs, do you expect this active ETF boom to continue? Lucas: I do, for a couple of reasons. First, the demographics. Boomers are retiring in droves and shifting from accumulation to distribution. They want income products. Second, the mutual fund to etf conversion wave is still early. I think we'll see more large asset managers — like Capital Group, like Fidelity — convert more of their flagship funds. Third, the SEC has been accommodating. They've approved multiple new structures. Luna: But there's a risk of proliferation, right? How many buffered ETFs do we need? There are already hundreds. Lucas: It's getting crowded. And some of these products have high expense ratios relative to what you get. The Innovator ETFs charge around 0.79 percent. For a buffered outcome, that's not cheap. Investors need to read the prospectus carefully — understand the mechanics, the caps, the buffers. It's not a set-it-and-forget-it product. Luna: And with JEPI specifically, the fee is 0.35 percent, which is reasonable for an active strategy. But the options premium is not guaranteed. If volatility collapses, the premiums shrink. Lucas: Right. In a low vix environment, selling options is less lucrative. JEPI's distribution has been fairly stable, but it can vary. And the VIX today is around 14, which is moderate. If it drops to 10, the income stream could dip. Luna: So the bull market has been kind to these products. But if we enter a sustained downturn, we might see outflows. Lucas: Absolutely. That's the stress test. JEPI hasn't really faced a multi-year bear market. It launched in 2020, had the COVID crash right away, but then we had the 2022 correction. It held up okay because the options premium cushioned the blow, but it still lost about 12 percent that year. That's not a disaster, but it's real. Luna: And for the defined-outcome ETFs, the real test is a prolonged flat market — you could get whipsawed. The buffer resets each year, so if the market goes up and down but ends flat, you might still hit the cap and then get no upside in the next year. Lucas: Exactly. The sequencing matters. These are complex products dressed up in simple marketing. I think advisors have a responsibility to explain the scenarios to clients. But the industry is moving fast, and education often lags. Luna: So what should the average listener do if they're considering an active ETF? One practical takeaway. Lucas: First, understand what you're buying. If it's a covered call fund, know that you're capping upside. If it's a buffered fund, know that the buffer applies only to the specific outcome period — if you sell early, you might not get the protection. Second, look at the fee. Some of these charge 0.70 percent or more. For that money, you could buy a cheap index ETF and a put option yourself, though that's more work. Third, consider your time horizon. If you're 30 years old and accumulating, you probably don't need JEPI. If you're 65 and drawing income, it might be a fit. Luna: That's clear. And for the industry, the bull market is making everyone look smart. The real test will come when the cycle turns. Lucas: It always does. But for now, the innovation is giving investors more tools. The challenge is using them wisely.