For investors looking for a high yield and a consistent monthly dividend payout, the Parametric Equity Premium Income ETF (NYSEARCA:PAPI) offers an attractive new choice. I’m bullish on PAPI based on its attractive yield, monthly payments, diversified portfolio, and reasonable expense ratio.
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What Is the PAPI ETF’s Strategy?
According to the ETF’s sponsor, investors can use PAPI to “gain exposure to an actively managed portfolio of U.S. companies that have demonstrated high current income with a systematic call writing program that seeks to generate additional yield.”
Essentially, PAPI combines income from the dividend payments from its holdings with income it earns from selling covered calls against its holdings to create monthly payouts for its investors.
This strategy can be an effective way to generate a large yield and a steady stream of monthly payouts.
The Pros and Cons of This Popular Strategy
If you’re thinking that there must be some kind of tradeoff here, you’re right. The tradeoff that investors should be aware of is that they potentially sacrifice a degree of upside from price appreciation because if PAPI’s holdings surpass the strike price for the covered calls it sells, PAPI doesn’t capture this additional upside.
To illustrate this with a simple example, PAPI’s top holding is ExxonMobil (NYSE:XOM). If PAPI hypothetically sells one contract (one contract represents 100 shares when exercised) of June 21 ExxonMobil calls with a strike price of $110, the fund will receive a premium of ~$32 at current prices from the buyer of these calls that it can use to distribute to holders.
But let’s say shares of ExxonMobil suddenly surge to $120 because oil prices spike and stay there until the options expire. In this case, PAPI is still obligated to sell these shares to the buyer for $110 on the closing date, meaning that holders missed out on $1,000 worth of capital appreciation from ExxonMobil’s run to $120.
That being said, if shares of ExxonMobil stay below the strike price, PAPI can simply rinse and repeat, selling new covered calls to continually generate additional income on a repeated basis.
As you can see, the strategy has its pros and cons, but it generates a steady supply of income. Assuming that an investor understands these dynamics and is comfortable with the fact that they will likely forgo a degree of upside from capital appreciation at some point, PAPI can be a useful tool for generating yield and creating steady monthly income within one’s portfolio.
Following the success of the JPMorgan Equity Premium Income ETF (NYSEARCA:JEPQ), which has grown into the market’s largest actively managed ETF, this strategy has become popular in recent years. PAPI is one of several new ETFs launched in the past year or so that employs this investment strategy.
Compelling Monthly Payout
So, what kind of payouts does this strategy facilitate for PAPI’s investors? It turns out that they are pretty compelling.
The fund launched last October (we covered it at that time and wrote about its potential for generating attractive income for investors), and since that time, it has made payouts to its holders each month.
While the payout amount is variable, payments have ranged between a low of $0.12 in January to a high of $0.21 last December. The most recent dividend payout for PAPI was $0.18 in May.
Many financial websites will show that PAPI is yielding 4.5%, and this is true on a trailing 12-month basis. But because PAPI only launched in October, it has only made seven monthly payments, so this number doesn’t really capture what its real yield will look like. PAPI’s distribution yield is actually a much higher 8.4%. This is calculated by using its most recent payment of $0.18 and multiplying it by 12 to ascertain what the yield looks like on a forward-looking basis.
While this method is imperfect as the levels of future payouts are not set in stone, it gives investors an idea of what PAPI’s yield could look like over the course of the next year.
This 8.4% yield is compelling. Keep in mind that the S&P 500 (SPX) only yields an underwhelming 1.3%. Also, Vanguard’s so-called high-yield dividend ETF, the Vanguard High Yield Dividend Index ETF (NYSEARCA:VYM), yields just 2.9%.
Even with interest rates at their highest levels in years, 10-year treasury bonds yield just 4.27%, or about half of what PAPI yields on a forward basis. The aforementioned JEPI yields 7.7% on a forward basis, which is certainly great but not as high as PAPI’s payout. Therefore, PAPI’s yield features a compelling yield, no matter what way you slice it.
PAPI’s Diversified Holdings
PAPI offers investors excellent diversification and exposes them to very little concentration risk. The fund holds 184 stocks, and its top 10 holdings account for just 9.3% of the fund.
You can check out an overview of PAPI’s top 10 holdings below using TipRanks’ holdings tool.
How Much Is PAPI’s Expense Ratio?
Another attractive aspect of PAPI is that it charges an expense ratio of just 0.29%, which is especially attractive when taking into account that it is an actively managed fund running a fairly complex strategy. For comparison, even the much larger JPMorgan Equity Premium Income ETF charges a slightly higher expense ratio of 0.35%.
Other newer funds from smaller competitors with similar strategies, like the NEOS S&P 500 High Income ETF (BATS:SPYI), the REX FANG & Innovation Equity Premium Income ETF (NASDAQ:FEPI), and the NEOS Nasdaq 100 High Income ETF (NASDAQ:QQQI) charge much higher rates of 0.68%, 0.65%, and 0.68%, respectively.
Is PAPI Stock a Buy, According to Analysts?
Turning to Wall Street, PAPI earns a Moderate Buy consensus rating based on 124 Buys, 53 Holds, and eight Sell ratings assigned in the past three months. The average PAPI stock price target of $29.28 implies 13.5% upside potential from current levels.
A Strong Choice for Steady Income
In conclusion, as long as investors are aware of the pros and cons that this strategy presents, I believe PAPI is a strong choice for generating a steady stream of above-average income in an investor’s portfolio. Because of its potential limits in terms of capital appreciation, I certainly wouldn’t put my entire portfolio into PAPI, but it looks well-suited to play a role of generating income as one part of a diversified portfolio.
I’m bullish on PAPI based on its attractive 8.4% yield, appealing monthly payout schedule, diversified portfolio, and favorable expense ratio.
