Do not be alarmed by the closing of JP Morgan Indexed ETFs. I say this even as I believe this may be part of an emerging trend. Many mutual fund companies known for touting active management but stuck their feet in the water with ETFs will likely follow suit.
Why? A number of large mutual fund companies known for active management, including Fidelity, tried adding passive ETFs to their roster. But in 2019, rule changes lowered the legal expenses for actively managed ETFs. Shops renowned for active management are likely to continue to delist indexed funds of less than $200 million in order to promote higher-fee active funds.
J.P. Morgan Asset Management is a good example of a company at the forefront of this trend. The company announced in a recent press release that it will liquidate two exchange-traded funds: JPMorgan U.S. Minimum Volatility ETF, JMIN, and the JPMorgan U.S. Dividend ETF, JDIV.
The release also included the following technical-sounding jargon:
Shareholders of each of the funds can sell their shares on the NYSE Arca exchange until market close on Sept. 6, the designated last trading day. The funds will stop accepting creation orders from authorized participants after the Sept. 6 market close, and shares will be delisted ahead of the Sept. 7 market open. Shareholders who continue to hold shares of either of the Funds on the Funds’ designated aforementioned liquidation date will receive a liquidating distribution of cash in the cash portion of their brokerage accounts equal to the amount of the net asset value of their shares. The funds are set to be liquidated on Sept. 14.
What does this all mean for holders of JMIN and JDIV? There is absolutely no reason to worry. First, they are protected by the underlying assets held by the fund. I believe that rather than wait for liquidating distributions, most fund shareholders should consider selling their shares online sometime between 10:30 AM and 2:30 PM using limit orders. Both JMIN and JDIV generally have spreads kept $0.01 apart so shareholders should realize a price very close to the fund’s Net Asset Value (NAV).
Since the underlying stocks of both funds are very liquid and both funds had assets of less than $60 million the fact that other shareholders will be selling should not affect the share price very much because market makers will step in if the fund drifts too far from NAV. This is one of the big advantages of ETFs over closed-end funds.
Active vs. Passive
Why is JP Morgan liquidating these two ETFs that together accounted for approximately $110 Million under management?
JP Morgan Asset Management’s philosophy is that actively managed funds serve investors better than passive funds. Prior to SEC rules changes in 2019 facilitating the entry of semi-transparent actively managed ETFs, passively managed ETFs constituted more than 90% of the assets in the ETF space.
But that proportion is changing with the SEC innovation combined with increasing investor and provider awareness that actively managed mutual funds are much more process-, cost- and tax-efficient in the ETF structure than they had been in the traditional structure. In JP Morgan Asset Management’s case, they probably prefer to focus on products that utilize the company’s core in-house strength and expertise. The decision to drop passive products in favor of active has probably been bolstered by the quick success enjoyed by the JPMorgan Equity Premium Income ETF, JEPI. It has accumulated more than $12 billion under management in just two years of existence.
During the past year, both JDIV and JMIN handily outperformed the S&P 500 Index and more than 75% of non-leveraged equity funds with above-average yields and below-average betas. It would seem that investors during this period should be happy with these results and are probably less than thrilled that the funds are closing. That said, let’s look at potential replacement holdings for owners of JDIV and JMIN.
The most popular ETF in the minimum volatility space is iShares MSCI USA Min Vol Factor ETF, USMV, with $30 Billion in AUM. The most popular ETF in the high dividend space is VYM, the Vanguard High Dividend Yield ETF with nearly $50 Billion in AUM. Investors preferring to combine both objectives may wish to add Invesco S&P 500 High Dividend Low Volatility ETF, SPHD, to their radar screen for potential consideration. For an active comparison in the low volatility and high-income space, DIVZ, the TrueShares Low Volatility Equity Income ETF is also worthy of including in your research.
A quick summary
Let’s take a closer look at possible replacement holdings:
USMV, iShares MSCI USA Min Vol Factor ETF
The fund typically overweights defensive, dividend-paying sectors. USMV’s optimizer also aims to keep other risk factors marketlike as it dials back on volatility.
VYM, Vanguard High Dividend Yield ETF
VYM tracks the FTSE High Dividend Yield Index. The index selects high-dividend-paying U.S. companies, excluding REITS, and weights them by market cap.
SPHD, Vanguard High Dividend Yield ETF
SPHD tracks a dividend-yield-weighted index comprising the least volatile, highest dividend-yielding S&P 500 stocks.
DIVZ, True Shares Low Volatility Income
DIVZ aims to curate a portfolio that is less volatile and has higher dividend yield than the S&P 500. The fund advisor initially screens U.S.-listed securities for sustainable dividend growth using various quantitative and qualitative indicators. Then high-quality companies are identified based on high cash flow, stable revenue streams and capital reinvestment programs. Finally, the fund advisor selects securities trading at attractive valuations with low volatility. The actively-managed fund’s high-conviction and low-turnover strategy results in a diversified portfolio of 25-35 stocks.
JEPI, JP Morgan Equity Premium Income ETF
The actively managed fund selects stocks from the S&P 500 Index using a process to identify value stocks with favorable risk/return characteristics along with ESG considerations. The final portfolio looks to hold those securities with lower volatility relative to the benchmark index. In addition, the fund’s adviser enters equity-linked notes to provide the returns of the S&P 500 Index with covered call options written. The objective is to provide the same return as the S&P 500 Index with lower volatility over a 3-5-year period combined with monthly income.
VOO, Vanguard S&P 500 Index ETF
It tracks the S&P 500 Index.
Using ValuEngine and Yahoo Finance reports, let’s look at the investment profiles of these five ETFs now in comparison with the Vanguard S&P 500 ETF, VOO.
Key Findings
1. All four potential replacement ETFs rated by ValuEngine are superior choices for the next year to the Vanguard S&P 500 ETF, VOO. DIVZ, USMV and VYM all get ValuEngine’s highest rating of 5. SPHD is also rated as above-average with a rating of 4 out of 5. JEPI, with considerable deployments in derivatives and fixed income securities, is not rated by ValuEngine while VOO gets a neutral 3 rating.
2. The most compensation in return for a given level of risk as measured by the Sharpe Ratio was posted by DIVZ, the TrueShares Low Volatility Equity Income ETF. This is demonstrated by its Sharpe ratio of 0.71. SPHD with 0.67 also had a better Sharpe Ratio than the 0.59 posted by VOO.
3. JEPI’s active management team has done an excellent job of meeting the ETF’s twin objectives of high dividend yield and low price volatility. It places highest of the six ETFs in both dividend yield and Beta. In fact, its current dividend yield of 11.9% is equaled by no US equity ETFs that do not use derivatives. DIVZ had the highest yield and the lowest Beta of the ETFs that do not use derivatives.
4. VYM performed best on valuation with the lowest price-to-earnings and price-to-book ratios among the six ETFs. DIVZ was second in this category with slightly higher valuations that were also much lower than the category’s third place finisher, SPHD.
Conclusions
ETF liquidations should really be thought of more as security retirements. Any investors can receive the full value of the underlying securities when sold or redeemed. In many ways, it is a shame that JP Morgan opted to close JDIV and JMIN as both had fulfilled their investment objectives very well in a very tough environment for equities. My belief is that given recent regulatory standards relaxing constraints on active management in the ETF structure, JP Morgan felt that active ETFs such as JEPI were a better fit for the firm’s investment profile.
Indeed, investors currently holding JMIN and JDIV would have invested in a similarly low Beta ETF with a much higher dividend yield by purchasing actively managed JEPI as long as they were comfortable with the fact that the fund is an equity hybrid that also holds bonds and derivatives and is semi-transparent with its current holdings.
For those with the same goals and who prefer using fully transparent ETFs that only hold stocks, DIVZ appears very worthy of consideration. Even better news for those needing to redeploy assets into conservative ETFs with superior dividend yields to VOO, all of the ETFs reviewed including USMV, VYM, and SPHD all performed very well in the past 12 months and look to be well-positioned for conservative investors. This may be especially true if the equity markets remain volatile and continue to be characterized by above-average economic and geopolitical risk profiles.
This article is reprinted with permission. Herb Blank is a senior quantitative analyst at ValuEngine and senior consultant and practice leader in the Global Finesse Product Strategy and Implementations Consulting Practice. He has more than 30 years of experience in financial product innovation and quantitative analysis. Recognized as a pioneer in the exchange-traded fund (ETF) industry, Blank established the first family of ETFs to trade on the NYSE and was a portfolio manager for the fund. He is credited with the product development and launch of iShares, GLD and X Shares. He is also well known for his development of the construction and maintenance methodologies for Dow Jones Global Indexes.
