The JPMorgan Equity Premium Income ETF (NYSEARCA:JEPI) has had a remarkable rise, becoming the largest actively-managed ETF with over $30 billion in assets under management (AUM) just three years after launching. This success has inspired other managers to create ETFs with similar strategies, and a new one that Morgan Stanley (NYSE:MS) recently launched, called the Parametric Equity Premium ETF (NYSEARCA:PAPI), looks particularly interesting.
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The appeal of these ETFs lies in their ability to pay monthly dividends and generate a relatively high yield by owning dividend stocks and selling covered calls to generate income.
I’m bullish on PAPI based on its monthly dividend strategy, its carefully diversified portfolio, and its cost-effective expense ratio.
What is the PAPI ETF’s Strategy?
PAPI is a new fund that began trading on October 16th. It currently has just $21.2 million in AUM, although this is likely to grow over time as the fund becomes more well-known and begins to establish a track record of paying monthly dividends.
Morgan Stanely says that PAPI “seeks to provide consistent monthly income while maintaining prospects for capital appreciation.”
PAPI’s strategy is similar to JEPI and other incumbents in the space. It gives investors “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.”
PAPI’s goal is to be a “low-cost and transparent ETF that seeks competitive performance, consistent monthly income distributions, and tax efficiency.”
Like its peers, PAPI appeals to income investors. It will pay a monthly distribution, and it does this through a combination of owning a large number of dividend stocks and selling covered calls in an attempt to generate additional income.
This is a great strategy for investors looking for monthly income. However, it should also be pointed out that these ETFs most likely leave some returns on the table because selling covered calls will naturally cap some of the upside from their holdings in terms of price appreciation.
As long as investors understand this dynamic and are okay with potentially forgoing some price appreciation in exchange for a steady stream of monthly income, then an ETF like PAPI is a worthy part of a balanced portfolio.
An additional note is that PAPI is an actively managed fund, and it is run by a team of six experienced portfolio managers. Between them, PAPI’s six portfolio managers have 125 years of industry experience.
Diversified Portfolio of Dividend Stalwarts
PAPI offers excellent diversification. It owns 181 stocks, and its top 10 holdings account for just 7.9% of holdings, so there is no concentration risk here. Below, you’ll find an overview of PAPI’s top 10 holdings using TipRanks’ holdings tool.
As you can see, PAPI owns a host of companies that are well-known for their high dividend yields and longstanding track records of paying dividends, like Verizon (NYSE:VZ), AT&T (NYSE:T), Raytheon (NYSE:RTX), and Coca-Cola (NYSE:KO).
These companies may not be the most exciting from a growth perspective, but they all feature above-average dividend yields and have paid these dividends for a long time.
Another attractive aspect of PAPI is that these holdings are inexpensively valued. The price-to-earnings ratio of its portfolio is 14.2 versus the S&P 500’s (SPX) price-to-earnings ratio of 20.4.
Waiting for PAPI’s Dividend
Because it just launched last month, PAPI has not yet paid out a distribution, so we don’t yet know what its dividend yield will be.
That said, its stated intention is to pay a monthly dividend. Once it gets going, it seems reasonable that it will generate a dividend yield that is somewhere in line with its peers like JEPI, the JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ:JEPQ) (a tech-centric counterpart to JEPI) and the NEOS S&P 500 High Income ETF (BATS:SPYI) (another new JEPI competitor), which feature dividend yields of 9.1%, 10.8% and 12.1%, respectively.
Reasonable Expense Ratio
While PAPI’s expense ratio of 0.29% isn’t exactly cheap compared to the broad universe of ETFs, it has to be said that it’s actually a very reasonable fee for an actively-managed ETF. Many actively-managed ETFs have much higher expense ratios of 0.50%, 0.75%, or even higher, making PAPI’s 0.29% expense ratio something of a bargain.
Comparing PAPI to its peers with similar strategies, its expense ratio is even cheaper than that of the much larger JEPI, which charges a slightly higher 0.35%. JEPQ also charges 0.35%, and SPYI charges a much higher 0.69%.
PAPI’s 0.29% expense ratio means that an investor putting $10,000 into the fund will pay $29 in fees over the course of a year. Assuming it maintains this same expense ratio and returns 5% per year going forward, this same investor would pay $93 in fees over the course of three years, which is reasonable enough.
Is PAPI Stock a Buy, According to Analysts?
Turning to Wall Street, PAPI earns a Moderate Buy consensus rating based on 119 Buys, 53 Holds, and 10 Sell ratings assigned in the past three months. The average PAPI stock price target of $27.41 implies 10.3% upside potential.
The Takeaway
With an experienced team of active managers, a reasonable expense ratio, a diversified portfolio, and a goal of paying a monthly dividend, PAPI looks like an attractive choice for income investors.
While we don’t yet know what PAPI’s dividend payout will look like since it just launched and has not yet paid a dividend, it seems likely that it will be in line with peers like JEPI and others. Investors who want to wait to see what the payout will look like before starting a position have the option to do that as well.
JEPI’s rapid ascent has led to a whole new cohort of similar ETFs that own dividend stocks and sell covered calls to generate monthly income. Time will tell if PAPI or any of the newcomers will displace JEPI, but they don’t necessarily have to. This is becoming a popular class of ETFs with plenty of room for multiple winners.
Furthermore, investors who already own and like JEPI can consider adding PAPI to their portfolio to supplement this dividend income and diversify by adding another income stream to their portfolio. I own JEPI and am adding PAPI to my watchlist. I like the idea of receiving a monthly dividend payment from JEPI and then getting another one from PAPI on a different date.
