Morningstar Advisor - June/July 2011 - (Page 38)

Spotlight Lower Fees, Competitive Returns Help More 529s Make the Grade By Josh Charlson Still, college savers and advisors must do careful research to ensure that they know what they’re buying. With industry assets topping $120 billion, 529 plans have become an important tool for many Americans’ college savings. The plans feature investments that grow tax-free and often are shielded from state taxes as well. The 529 industry has matured considerably in recent years to feature more investment choices that are cheaper and easier to understand. Morningstar’s analysis of these investments also has matured. After judging the best and worst in the industry for seven years, Morningstar issued its first-ever analyst ratings and reports on plans in 2010. We also created new categories specifically designated for investments in 529 plans, making it easier to compare risk-adjusted returns and fees among investments with similar mandates. Finally, Morningstar published an in-depth Industry Survey that cataloged significant features and trends across the broader 529-plan industry. Through this extensive research, Morningstar’s analysts picked up on a few trends that are particularly relevant to investors and advisors. No Consensus on Asset Allocation of new assets in 529 plans flow to such investments. Similar to target-date funds, 529 age-based options’ asset allocation shifts from equityheavy asset mixes when a child is young to mostly bonds and cash as college nears. The average 529 age-based option’s glide path starts with 80% equities and dips down to 10% equities when the beneficiary is 19 years old (Exhibit 1). That drop—far more pronounced than target-date funds’—reflects the limited time that college investors have to recover from bad market conditions and the high fixed costs associated with a college education. But not every plan or individual age-based investment becomes similarly conservative near the enrollment date. In fact, 529 options designed for 15-year-olds have a wide disparity in asset allocation, with some options’ equity allocation higher than 50% for beneficiaries who are one year into high school (Exhibit 2). Another difference between the glide paths of 529 plans and target-date series is that many 529 plans have multiple glide paths while target-date series have a single path. Several 529 plans, including those run by TIAA-CREF and Franklin Templeton, have added multiple glide paths since the 2008 market downturn. In 2010, 38 of the 82 529 plans nationwide contained multiple glide paths, often labeled “growth,” “moderate,” and “conservative” to more intuitively reflect the path’s exposure to equities throughout the investment. Ultimately, this range of choice in asset allocation is valuable for advisors who may be helping a client choose a 529 plan. Within a client’s home state, the advisor may be able to select an appropriate glide path from among several. And once the state tax advantage is considered (or discarded), advisors can look to other states to seek an option suitable for the client’s risk tolerance and financial situation. Open vs. Closed Architecture As the 529 industry has matured, an increasing number of plans feature money managers from more than one firm. These so-called “open architecture” plans usually mix unaffiliated managers in both distinct static options and within age-based options. In theory, open-architecture plans confer an advantage because they can choose “best of breed” asset managers—just as an institutional money manager would. In reality, however, open-architecture plans have not outperformed closed-architecture plans on a risk-adjusted basis (as measured by the Morningstar Rating) (Exhibit 3). That’s at least partly due to cost. On average, closed-architecture 529 plans have lower expense ratios than those that mix managers from multiple Age-based investment options—which investors choose based on the child’s age or expected college matriculation date—have come to dominate the assets in 529 plans. Anecdotal evidence suggests that 40% to 50% 38 Morningstar Advisor June/July 2011

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2011

Morningstar Advisor - June/July 2011
Letter From the Editor
Questions for the Secret Society
Are 529 Plans a Useful Tool for Clients’ College-Savings Goals?
Taking the Lead
How to Sell Covered Calls
The College-Savings Challenge
Time to Play Defense?
Four Picks for the Present
Investment Briefs
Careful What You Wish For
Caution in Utilities After Japan Crisis
Blossoms and Thorns in the 529 Garden
Lower Fees, Competitive Returns Help More 529s Make the Grade
Morningstar Grades 529 Plans
529 Risks Include the Political
Researching 529 Plans Made Easy
How Closed-End Funds Are Born
Boutique Within a Bank
The Inefficient Pricing of Moats
More Steak Than Sizzle
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Dangers of Demonizing

Morningstar Advisor - June/July 2011