Even in a world where interest rates are higher than they were a few years ago, a return of over 20% still stands out no matter what kind of environment we are in, and that is exactly what the REX FANG & Innovation Equity Premium Income ETF (NASDAQ:FEPI) offers investors.
I’m bullish on this newer, still under-the-radar dividend ETF from REX Shares because of its massive yield, attractive monthly payout schedule, and portfolio of highly rated technology stocks.
What is the strategy of the FEPI ETF?
FEPI’s strategy is to own large technology stocks (the 15 stocks in the Solactive FANG Innovation Index) and issue covered calls against these holdings to create greater income potential.
It’s a strategy that has grown in popularity in recent years, as similar funds like the JPMorgan Equity Premium Income ETF (NYSEARCA:JEPI) and the JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ:JEPQ) have become some of the most popular ETFs on the market.
Essentially, FEPI sells covered calls against its holdings and uses the option premiums it receives from the sale of these calls to pay its holders a monthly distribution. This can be a great strategy to generate stable and above-average income, as evidenced by FEPI’s frequent payouts and great returns. These large-cap technology stocks attract significant investor interest and are characterized by high volatility, making them particularly suitable for generating attractive option premiums.
The downside to this strategy is that FEPI holders may sacrifice upside for capital growth, because if their holdings rise above the strike price for the calls it sells, FEPI holders miss out on this additional benefit.
For example, FEPI’s largest holding company is Nvidia (NASDAQ:NVDA). This is a theoretical example, but let’s say FEPI sells one contract of June 21 Nvidia calls with a strike price of $130 for a premium of $120. In this hypothetical example, the fund benefits by receiving a ~$120 premium from the buyer of the options for selling these calls, which it can distribute to their holders.
However, if Nvidia’s shares rise above $130 on the closing date, to say $150, the fund is contractually obligated to sell those shares to the buyer of the call at the contractual price of $130, meaning it has not benefited from a appreciation of $20 per share above the strike price.
However, if Nvidia’s shares remain below the strike price, the fund managers can sell new calls against them and repeat the process again to continually generate consistent income.
As long as investors understand these potential tradeoffs and accept that they are likely to miss out on some upside from price appreciation from time to time, this can be an attractive and effective strategy for generating significant income each month.
Huge yield
It is important to note that the amount of FEPI’s monthly payout is not fixed, and the fund does not guarantee that it will make a monthly payout.
That said, the fund has been remarkably consistent so far since launching in October 2023, making a payout every month – the smallest of which was $1.09 in April. We reviewed FEPI shortly after its launch last year and wrote that it had the potential for significant payouts, and this has largely come to fruition.
Many websites list FEPI’s yield at 14.9% – which is still incredibly attractive – but that doesn’t tell the whole story. This is the return over a twelve-month period, and the fund only launched at the end of last year, so it has only made seven months’ worth of payments so far.
Looking at returns over time provides a clearer, but imperfect, picture. If we use the most recent $1.16 payout in May as a monthly payout going forward, the fund boasts a huge distribution yield of 25.2%. Even if payouts decrease slightly from May levels and fluctuate, this return will still be very high.
It is difficult to underestimate how great this return is. The S&P500 (SPX) yields just a paltry 1.4%, while 10-year government bonds yield a risk-free 4.4%. Even FEPI’s aforementioned peers, such as JEPI and JEPQ, yield 7.7% and 9.8% respectively over time (using the same methodology as above).
Concentrated holdings
FEPI owns 15 stocks, and its top 10 holdings represent 67.8% of its portfolio. FEPI is not very diversified and very concentrated, but diversification is not the aim of the fund.
Below is an overview of FEPI’s top 10 holdings using TipRanks’ holdings tool.
As you can see, FEPI’s portfolio is largely made up of the highly rated large-cap tech stocks that have boosted the market in recent years, such as Nvidia and its fellow magnanimous seven stocks, fellow chipmakers Micron (NASDAQ:MU) and Broadcom (NASDAQ:AVGO), and a handful of other technical names.
These holdings are highly rated by TipRanks’ proprietary Smart Score system. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It scores stocks from 1 to 10 based on eight key market factors. A score of 8 or higher equates to an Outperform rating. Eight of FEPI’s ten largest holdings have Smart Scores equivalent to Outperform, and three of them, Broadcom, Amazon (NASDAQ:AMZN), and alphabet (NASDAQ: GOOGL), with “Perfect 10” Smart Scores.
FEPI has an Outperform equivalent ETF Smart Score of 8.
How much does FEPI charge?
A disadvantage of FEPI is that the expense ratio of 0.65% is quite pricey. An investor who puts €10,000 into the fund pays €65 in fees annually. However, this is an actively managed fund with a fairly complex strategy, so the higher expense ratio isn’t necessarily surprising. If the fund can continue to make monthly payments to holders and maintain such high returns, few investors will complain about the expense ratio. However, if FEPI falters, more investors will question the expense ratio.
Not without risks
As discussed above, investors in the fund may be missing out on some of the benefit of the price appreciation in exchange for this large return.
Additionally, this is a fairly new fund and strategy, so it remains to be seen whether the strategy will evolve over time or whether it can continue to pay out this much in the long run.
Finally, the fact that the fund is highly concentrated and highly exposed to only one part of the market, namely large-cap technology, exposes investors to significant risks if this market segment suffers.
Is FEPI Stock a Buy According to Analysts?
As for Wall Street, FEPI earns a consensus rating of Moderate Buy, based on thirteen Buys, four Holds, and zero Sell ratings assigned in the last three months. The average FEPI stock price target of $59.89 implies an upside potential of 8.7% from current levels.
The takeaway: A standout investment for income investors
Even in a world with higher returns, FEPI’s return of over 20% stands out. I’m bullish on the ETF based on this huge return, monthly payout schedule, and highly rated portfolio.
As long as investors understand and are comfortable with the fact that these large returns come with the trade-off of potentially leaving some of the potential upside from capital growth on the table, FEPI can be a good option for generating monthly income. For this reason, I wouldn’t necessarily allocate my entire portfolio to FEPI, but I believe it can be a useful income generating tool within a diversified portfolio.
Revelation
