Talk Your Book: The Biggest Active ETF

Today's Animal Spirits Talk, your book is brought to you by JP Morgan. Go to JPMorganassetmanagement.com to learn more about their whole suite of covered call option ETFs, option income ETFs. It's JPMorganassetmanagement.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. On today's show, a returning champion guest, this is probably his third time, fourth time coming on the show. Yes, something like that. Hamilton Raynor from JP Morgan still holds the crown for the largest active ETF in the game, Jephy. It's pretty impressive because it's been the largest active ETF for a few years now and hasn't been dethroned. I wonder what number two is. Probably Jep Q, but outside of, I wonder what number three is. It's just, it's interesting. We've talked about these covered call option strategies in the past. It's just interesting in a decade that has been fueled by speculation, right? Everything is speculation these days. Prediction markets and gambling on sports and trading on your phone and zero day options, that these are more conservative type of investments that have obviously taken mind share. It's just an interesting dichotomy to me, that these aren't like the speculative fever, right? These are more, for lack of a better word, boring. I believe we spoke about this probably with Hamilton, but years and years ago, Josh and I were in a meeting with a wholesaler probably 2013. And at that time, people were still very scared of stocks, very much in the aftermath of the GFC. Still, the cloud was still hanging over us. And this guy was pitching high yield bonds as a way to dip your toe in the water, a little bit more beta, not quite stocks, but closer to stocks and bonds certainly. And needless to say, this is an obviously better solution for people that want equity exposure, but don't necessarily want all the smoke of the downside perfectly fine, not capturing all of the upside, if the S&P is up 30% in a year, I'm sure people would be just fine being up 26 or whatever it is. Right, people understand this. There's a trade off for the income. Yeah, trade offs. Yeah, that's right, Ben. I do think it's interesting that we've seen the popularity of these strategies, that there's now offshoots. All right, if you like this, but you want something different, here's another option. Here it is on the NASDAQ. Here it is where the income will be automatically reinvested for you, the option income, if you're not going to spend it. Here are some different ways to do this with different holdings. And so Hamilton gets into that with us today with some of their new funds that they're using on the S&P and more NASDAQ-like options. And I think this thing's are going to continue to just evolve and have more options. Pun intended, I guess, there? There you go. Okay, so we always love talking to Hamilton. And the last time we saw him, we mentioned, every time we go to future proof, I see him at the concert. That's the only place I see him is he's rocking out to the concert right next to us. Anyway, great guy. I always love catching up with him. Here's our talk with Hamilton Raynor from Giffy Morgan. Hamilton, welcome back to the show. Glad to be back. Good to see you guys in Miami. Thanks for having me. Great to see you too. I'm sorry we didn't get to spend more time together, but it was great seeing your face. We always see Hamilton at the music show. That's where I always run into. In the crowd watching the music. Absolutely. One of the highlights. All right, so Jepi is still the largest actively traded ETF. Got to be, right? It's the largest active ETF in the world by AUM. And holy cow, coming up the rear, Jep Q is a monster too. Jep Q has $33 billion in assets under management. This is recorded in Monday, March 30th. It has, and it makes sense though, Michael, because if you think about it, when else can you hear growth in tech, income, and having expected less risk and volatility? Those three things are evergreen when thinking about clients portfolios. Usually an income-oriented investor is missing out on growth in tech. That is true. That is true. There are, so we've covered this the previous times that we've had you on. There is no free launch, silver bullet. These things have trade-offs. You are going to be, not probably, definitely leaving some on the table in a rip-warring bull market. But the idea is that when you're in a drawdown, you're going to suffer less of the drawdown. And it's early in the year, but not that early. We're through the first quarter. So there's a couple components to that. Obviously the options premium health buffer, that a little bit. And Ben may not want to hear it, but I'll go there anyways. The active management of our stock selection has actually helped. So Ben, I'm sorry, but active management can help in both up and down markets. What are you coming at me for? I heard that you were a bogelhead. Oh, he sure is. Died in the wall. 80%. What are the stocks working this year? So you're like a high-quality, low-volic. What is the, if you had to put it down to a factor, what is helping this year? Yeah. So I wouldn't call it a factor. I'd say it's good old-fashioned stock selection. What's helping is JEPI by design, was designed to be one of the more conservative ways of getting income as well as a conservative equity. So how to think about that loan portfolio. Number one is very well-diversified. We cap every name at about 2%. So we're going to underweight the mega-span. The second thing is that we want to be well-diversified across sectors. And we know that whether it be communications or tech have actually become a huge part of the S&P, we cap every sector at about 17.5%. So the diversification across sectors and across names has actually been a nice tailwind. So 2022 was, correct me if I'm wrong, I feel like 2022 was the year of JEPI because it launched a Cambrian explosion of these derivative-based products inside of ETF. So the option overlays, all sorts of different strategies. But in 2022, not only did you protect the downside via the options in a down market, but it was the stock selection in 2022. It sounds like the stock selection is similarly adding alpha in 2026. What is the methodology behind this good old-fashioned stock picking? You're right. I mean, 2022, the stock selection and the sector allocations and being a more balanced allocation, not being as much in the megas, was absolutely a tailwind. When I think about what we do, we actually are lucky enough, Michael, to have boots on the ground across the world. We have 80 analysts. They all speak the same language when it comes to stock selection, a $200 million research budget. And when you have that opportunity to have access to management and to do the actual analysis, picking stocks that will give you a little bit more of the upside, maybe less the downside. Now, when I think about stock selection, one of the things that's important to me is it's not just how much you buy. Excuse me, it's not what you buy, but it's how much. Actually, stock selection is only 50% of the alpha. It's how much of it you buy. The weighting of it is also incredibly important. And so the strategy like Jepi and Jepq are actually balanced not to stock selection, but portfolio construction. I have a question for you about your process, because I don't know what the right answer is. Are you a guy that says, listen, the process is the process? This is what we do. All discipline. Or do you say, no, the process can evolve over time. Our stock selection can evolve, type the stocks we own. How are you? Are you like, no, it's set in stone or do you say, no, no, we're pretty flexible here? A couple of things I would say, Ben, I would say that there is a process, but the process is not that it's this way or the highway. It learns, it grows, it develops. As you get new information, I forget who we can attribute the quote to. I know you guys always know who said the quote, but when the information changes, I reserve the right to change my opinion. Was that Keynes? Yes, allegedly. I think it was allegedly Keynes. But the fact is, is we have a process where we look at cash flows, in a normalized world out three years, then forecast out 30 years of cash flows. And then we're trying to say, what is this company worth today? So is that a process? Yes. Are we going to change it based upon information or new sources or other things that we can glean? Absolutely. But you need to root yourself in something to create perspective. You just can't come in every day and say, what did I read on Reddit or Speaking Alpha and say, that's going to be my favorite name of the day. That's where actually people chop themselves up and I think it destroyed. There is no shortage of different option-oriented strategies. In fact, there's a glut. It's overwhelming. How should investors who are listening to this think about observing or diligence-ing you versus a competitor? What questions should they be asking? There's a couple of things to that, Michael. The first thing I would say is, we philosophically believe it's not just about income. It's about total return where income is a portion of it. You see these gaudy numbers in which there's huge, enormous distributions monthly or annually. What you end up seeing is people have massive NAV erosion. Clients, even if they got the income, oftentimes forget. They see their NAVs go from 100 to 80 to 60. That's not actually a good thing from an overall portfolio perspective. You don't like NAV erosion. The second thing is, I'll come back to something that Ben alluded to. That is, you should almost ignore the income. Why? All of these strategies are going to give you income. You first need to start with what kind of stocks you want to own. With a strategy like JEPI, you're looking for higher-quality names with predictable earnings. With a strategy like JEPQ, you're looking for more of a growth in tech footprint. When you think about some of these other strategies, if you just look at the income, you may be at a stock you don't like, but because of the income you buy it, if you look at some of these other strategies that I would say, some folks say you need a PhD to understand what they do, a lot of financial engineering, you don't need to be complex to make money. You don't need to be complex to invest. It kind of goes back to what is one of the age-old philosophies that I have. If I can't explain it to somebody, I probably shouldn't be investing in it. With our strategies, you understand what you're buying, the type of stocks, you're understanding how the income is generated, you're understanding that at a place like JPMorgan, we have a not just portfolio managers and analysts, it takes a village to manage strategies like this, middle office, back office, clearance, custody, cloud management, cash management, corporate actions, trading, pricing, cap markets. I mean, you need that village. As you guys know, stocks don't die. Stocks either you're taking over, they go bankrupt or they live forever. Options die. You need that team of people in order to do these things well. And so I would say it's not about that big gaudy income number. It's about really creating that balance of tour, turn and income. Michael, those are some of the things I would say. I'm curious. So you have the biggest active ETF. I don't know if they give you like a belt to wear around the office for that. But there's all these other, Michael mentioned there's been an explosion in these products. Do all these other option income seeking funds, do they, is it a drop in the bucket in the options market or could these funds actually change the market in some ways? Is there any difference because all these funds are seeking this income? Or is it just like, no, no, no, you don't even realize how big the options market is. This is nothing. It's a good point, Ben. And the first thing I would say is that the S&P 500, the granddaddy of all options, actually trades over three and a half trillion dollars per day. What? And one of the pushbacks I'll get, and Michael's going to push back is like, how about those zero dates? Well, let's just say that's half. It's still 1.75 trillion per day. These are some of the most liquid, if not the most liquid equities in the world. So I would say if you're using S&P 500 index options as the bench, as the, as the options, they truly are, you know, a small fraction of the overall market. The NASDAQ also trades in enormous amount, not nearly as much as the S&P, but a significant number, at least 600, 650 billion a day. And once again, those options are, and that's notional for both S&P and NASDAQ, those options and those strategies are still a tiny fraction. Where it could come into play is in some of the single names, because the fact is that there's only so big you could be, whether it be position limits or the actual number of options that trade on individual names. I would say the big guys, you know, the mag seven plus three, or whatever you want to call them, the fabulous 10 probably can withstand the amount of options that are trading, but as you go farther and farther down, it probably comes a little bit more challenging at some point then. So I was going to ask about the retail crowd getting into the option game in a big, big, big way. And I don't know if they're primarily using individual stocks or if they're using the indexes or both or whatever. But one of the things about JEPI, corrupting from wrong, that makes you different from a lot of the competitors is that you are not writing option overlays at the index level you're actually doing at the stock level. So talk about that dynamic. So actually in JEPI, we are doing options at the index level, not on individual names. Just kidding. Okay. But the reason we do that is something that's important. And that is you don't want to be having your winners taken away and left with your losers. Let's go back to November. What happened? I think Google is up about 15% and Nvidia was down 15%. If you sold options on both of them, you would have been capped out in your Google and eaten all the downside in Nvidia. But if you do option at the index level, you get all the alpha of Google as well as all the alpha with Nvidia, but you don't get capped down your winners and left with your losers. It's just not a good investment process. So what's next? So you'd have JEPI, which is high quality S&P 500-ish, JEPQ. I believe tried and true is what you say on a podcast, Ben. Okay. Blue chip, is that fair? Is it blue chip fair or not? Oh, I'll take blue chip. Oh, I love blue chip. All right. So what's next after JEPI and JEPQ? About nine months. Actually, you know, about eight months ago, we launched a strategy for young folks like yourselves. It's a call overwrite strategy. But instead of paying you out the distributions, we only pay out the dividends, but we keep the options premium inside the strategy. Cause imagine if I give you the distribution, only for you to give it back to me. It may create a taxable event. Why would you ever do that? So we have a strategy that reinvest the options premium. So it doesn't distribute it. That's number one. So we're the only firm that we're aware of that has the ability to pay out its income as a coupon, 10.99. That's JEPI and JEPQ. We believe we're one of the few, if not the only ones that can actually reinvest our options premium. And then just a few weeks back, we launched two strategies that we hope will defer a portion of the distributions. One on the S&P 500 called Rocky. We like to take our ROCY and then another one based on the NASDAQ ROCQ. And being both music guys, you guys could appreciate we will rock Q does not stink as far as a tag line. I like it. The commercial rights itself. So how does the before we get into these new strategies, how does the reinvesting option, how does that work in practice? So that's just it's more tax efficient and you say listen, I'm going to reinvest my dividends anyway. So are my income anyway? How does that work in practice? The fact is many people own income warranted strategies, whether it be stocks, mutual funds, ETFs, and only to give back these strategies, the money as part of a dividend reinvestment, right? Drips are one of the greatest things ever to actually continuously compound your wealth. But so if you have the ability to pay your bills and don't need that monthly distribution, but you like the risk profile of a call of right strategy, why would I make the distribution only for you to give it back to me? So Joy T, our little joy to your portfolio is about paying out the dividends because the IRS makes me pay out dividends, but instead of paying out the options premium, let it just accumulate inside the strategy compound and work for you. I don't think Keynes actually had that compounding eighth wonder of the world. I think everybody else besides Keynes has been attributed that compounding is the eighth wonder of the world. We'll give it to Einstein. Okay. So now explain. Einstein or Buffett. That's sure. So now, now explain to us the new strategies. What's the difference with Rocky and Rock Q? So Rocky is going to be a modestly active long portfolio benchmark to the S&P 500 doing S&P 500 index options. Rock Q is going to be a modestly active long portfolio benchmark to the NASDAQ 100 doing NASDAQ options. And our goal would be to defer some of the taxes associated with that distribution. So one of the ways of thinking about it, if an investor would prefer to defer, they should kick the tires on Rocky and Rock Q instead of Jepi and Jep Q. If they want 1099 income, hey, as you go, then Jepi and Jep Q. But there is one big point to your question, Ben, and that is Jepi is going to be that more defensive, higher quality portfolio, whereas Rocky is going to be something that looks a lot like the S&P 500. Okay. So you have like your, your sort of high quality min vol with Jepi, blue chip, and then more S&P and that. So you have like your, I guess, I don't know if it's volatility or risk levels, but you have your options now. Options within options. Right. Basically, we believe that adding a call of right strategy to a portfolio manage enables you to have multiple ways of winning, right? If you think about a call of right strategy, if markets go up, Michael said it best when we start off the call, we're not going to be able to keep up. But you still going to capture a healthy amount of risk adjusted return. And I know, you know, it's not about sharp ratio return, but being up significant, but with less risk. And then with, and that's what we would anticipate. You know, better, you know, better risk just returns to the upside to the downside, stock selection options premiums should help value out a little bit. But in that rangebound market, you're still going to get the dividends, the options premium. So those strategies complement a well-balanced portfolio carving out five, 10, 15, 20% from a traditional balanced portfolio. The question that becomes, do you want your income to be 10.99 coupon, Jepi, Jep, Q, would you like it to be reinvested in a, in a, in a pretty smart way, joy T, or do you like to potentially defer some of the taxes in a strategy like Rocky and Rock Q. So it is, it is what we're trying to give us choices as to how you get those monthly distributions or not, and if he's a joy T. This is a very, uh, this is a sort of a ridiculous question, given the pun that you're fishing in, but the size of this ETF is considerable. It's over $40 billion. And I would imagine based on the market environment that flows are accelerating. If I had to guess, there are some names in the portfolio that are not, now it's a very diversified portfolio. So it's not cap weighted. It's not like, uh, it's not like the SMP. Um, you know, you've got the largest position as of this recording is 1.8% of the assets. So maybe this is dumb question, but I'm too, it's too late. I'm talking about, I'm already down the road. Is there any worry about you guys getting too big about like, like, is there any worry about this, the scale and you pushing around some of these underlying names, especially in the, at the option level, at the index level, or I guess we would cover that already. Nevermind. I'm paranoid. I worry about everything. And what I would say is when you think about the well diversified nature of the portfolio with 1.8% being the cap, think about that relative to virtually any strategy in the industry as benchmark to the SMP 500, Ben, that have big chunky weightings and so many different names. That diversification, I think is a tailwind and a benefit from an option. Perfect. If we did cover that, you know, over 3.5 trillion notional per day. Yeah, I think you're good there. 2026, it's been an interesting year, uh, as, as they all are. Are you seeing flows accelerating? We have seen some, some flows into the entire suite. Uh, Jeppe and Jeppe Q continue to, uh, see investors. Um, I think a lot of that is there's multiple ways of winning. I, you know, I love stocks. I've been a stock, jockey, my entire career and an option to shock my entire career. But they're, they're blunt stocks go up. You make money, stocks go down. You don't, when you put a strategy like this into your portfolio, there's multiple ways of winning a strategy like Jeppe held its own in 2021. It holds on again in 2022. And this year it's doing what you would expect hanging in pretty darn well. If we can help you perhaps not eat all the downside, you don't need to make as much money when the mark goes up. I know you guys talk a lot about investing for the longterm. I believe investing for the longterm, but one of the greatest ways of compounding wealth over time is losing less. And if we could help people stay invested and lose less over time, we think we're in a good spot. I was actually looking at this before we got on. It's kind of crazy to think since 2009, there's only been two down years on the S&P 2018 was a bad year. It was down almost 20% and then that was 2022 and then 2018 was down like 4%. So we haven't really investors have had it a little too easy. Actually, we haven't had a lot of down years. You know, the first decade of the century was a lot of down years, but we have it, though this cycle has been relatively easy, even though there's been drawdowns along the way. So we haven't had many, many down years even for the options to protect again. So I guess you're, you're set for, for that situation. I'm, I'm curious. If I know it's hard to get look through on ETF investors is a little harder than mutual funds, but do you get the sense that the income in these strategies keeps you, gives you a more consistent investor base? Do people buy and hold these funds more because they're receiving that regular income? I think that's part of it. I think the other part is the people witness days in which the market sells off and we hang in pretty well on most of them. That's number one. Number two, when I think about these strategies, going back to your first point, it's not meant to be one for one with the equity market. It's meant to be a portion of your equity and a portion of your fixed income. And if you think about it's strategy like JEPI as an example, if you take, you know, $5 on stocks and $5 from bonds, it's not that I don't like bonds, but I rather on JEPI and stocks than bonds. And this strategy would help you be more efficient as far as your portfolio construction. So if you want to put me in a head-to-head with stocks, with any of my optionary strategies, I would take stocks. Two things. One, the ride matters. I mean, you brought up, you know, 2008, you brought up 2022. I mean, I'm old enough to remember the late 90s, the early 2000s, the GFC. There have been, I mean, people forget the summer of 2011 when the US debt got downgraded and people freaked out when the market went down 14% of the week period, just because the year finished flat or up does not mean you didn't have to look into the, into the abyss. I mean, just think about it. Nothing happened last April. I bet you guys were both pretty darn busy last April because the S&P and the Bixby are flat in April. So I think managing that ride, it's easy in the rearview mirror, a little harder as you live through it. You mentioned like taking a little from stocks and a little from bonds. What's a fair way to benchmark these kinds of strategies? Is there an option benchmark that you use? Do you say, no, no, no, it's more like a 70, 30 portfolio or something like that. What, what, what do you think is a fair way for investors to benchmark against these strategies? I think the starting point is risk for risk. When I think about what you folks do, your goal is to maximize your client returns using the risk that they have allocated to you. So if you're going to invest in these strategies, you're going to have to keep your clients portfolios risk the same. So I mean, it's taking a little bit of stocks, a little bit from bonds. Since each one has a slightly different profile, that's how we think about it. There are some, some call overwrite indices. I'd say they're kind of imperfect. You know, they do options once a month. They do at the money option in some cases. But I think the best way of thinking about this is if you're going to add something to your portfolio, like anything else in life, does it add value? Does it increase your total return? Does it increase your stock ratio? Does it increase your up capture? Does it decrease your down capture? And if the answer to that is yes, then you're being very efficient in your client's risk budget, if you will. That's how I think about these type of strategies. They're not meant to replace your equities because they have less beta. They're not meant to replace your fixed income because they do have equity market beta. They're meant to compliment your well-established portfolio construction. So to me, that's where I want it to go in terms of how advisors are thinking about this, where it goes in the portfolio. This is obviously more like an equity than a bond. I would say that if you are using this as a fixed income substitute, you're going to have some really mad clients if and when there is an actual bear market. Would you agree? Without a doubt, which is why when we think about this, we think about it, as I said earlier, that risk for risk. Now, there are some parts of fixed income that it is similar. Not exactly similar. Credit, emerging market debt. That part of fixed income actually has equity market beta, but it is not a bond substitute. Bonds are bonds and stocks are stocks. And from a risk perspective, these strategies sit somewhere in between the two, Michael. How do you see clients using these? Do you really see people say, hey, you know what? I'm going to take 5% from my bonds and 5% from my stocks. It's going to be an offset or something like that. Or do you see that like, is it almost like an alternative or a middle ground or are you saying, no, people just have their expectations for what this can do. And it's just floating in the portfolio. Like what's the portfolio management usage of this fund? I think there's three ways, Ben, to see people using the portfolio. Number one, as an anchor tenant for an income warranty client. Income is one of those things that's evergreen. People love income. And if you can actually start with a high quality group of stocks that are expected to have less risk and less beta and throw off a healthy amount of income, it's a good anchor tenant. Or if you have a client that's like, I want to own something a little growthier and a little techier with a healthy amount of income and expected at less risk and beta. Once again, that anchor tenant to an income warranty portfolio. And you guys know there are lots of people that built income focused portfolios. So we're seeing people use it as an income anchor tenant. We also see some people using it as a conservative equity, you know, with all that's going on in the world, all the uncertainty. These strategies are going to be equities, but have less risk and beta. But one of the interesting things around this strategy is when volatility goes up, we're expected to give you more income and more potential upside. So volatility is a tailwind. And you're seeing it today. As volatility has reared its ugly head, our strategies should benefit looking forward. But when you look at a traditional portfolio, what happens when volatility is higher? Spreads are probably wider and stocks are probably down. These strategies create a nice complement to those more challenging environments when the VIX goes up in your standard portfolio. And then lastly, we do see a lot of people taking their existing portfolio, peeling off some stocks and peeling off some bonds to buy these strategies. The question is how much in each? Well, it also depends upon your starting point. If you're very over rate equities, it would be more equities than fixed income. If you're underweight equities, it would be more fixed income and cash than equities. But if you're perfectly balanced, it's going to be that risk for risk that we talked about. And when you do that, you actually see the benefits of complementing a traditional asset allocation with strategies like this. All right, people who want to learn more about JEPI or JEPQ or your new funds, where do we send them? So if they want to learn more about JEPI, JEPQ, Rocky, RockyQ or Joyty, JPMorganassetmanagement.com. All right, thank you, Amazon. Appreciate it as always. Thanks for having me, guys. Appreciate it. Okay. Thanks to Hamilton as always. Remember to check out JPMorganassetmanagement.com to learn about all the funds we mentioned on the show today and then email us animalspirits.com. Personal emails, personal responses. We'll see you next time.