Morningstar Advisor - June/July 2011 - (Page 45)

Spotlight 529 Risks Include the Political By Laura Pavlenko Lutton Forming a partnership with state governments carries its own set of challenges and quirks. When you invest in a mutual fund, the name on the prospectus makes it clear with whom you’re forming a partnership. But with a 529 college-savings plan, the marketing brochure often features a grinning state treasurer more prominently than the asset-management company’s logo. By design, 529 plans are municipal securities, so a 529 account is a partnership first with state government and second with the asset manager running the 529 plan’s assets. No two states run their 529 plans the same way, and that can lead to interesting results for college savers. Wooing State Government though the states have found some creative ways to improve 529 investment options in the meantime, should trouble hit. Ohio, for example, started a new 529 plan in 2009 after its Putnam-run, advisor-sold 529 plan badly underperformed. Because Ohio couldn’t terminate its contract with Putnam, it hired BlackRock to run a separate plan. In October, BlackRock absorbed the Putnam-run assets when Putnam’s contract expired. Similarly, Illinois couldn’t fire Oppenheimer when its Core Bond fund sunk the 2008 returns of many of the state’s age-based investment options. Instead, Illinois sued Oppenheimer and insisted that other third-party investment options be included in the plan, including a raft of ultracheap Vanguard indexes. Such performance disasters have prompted some states to include investment-performance reviews as part of their contracts with the program managers. States have other recourse as well. Some have used the RFP process—or the threat of putting a plan’s program-management contract up for bid—to secure lower fees within the 529 plan. New York announced lower fees in its Vanguard-run plan in August, just before the contract was up for renewal. Elsewhere, the College Savings Plan of Nebraska hired a local company, First National Bank of Omaha, to replace Union Bank & Trust Co. as its program manager in late 2010. Along with that switch came much lower fees for investors. All told, more than 30 529 plans have lowered their fees over the past two years; this is a direct benefit to college savers and reflects a more-competitive landscape for asset managers running 529 accounts. Influencing Asset Allocation When states choose program managers to run their 529 plans, some take the investment options and asset allocations that the money manager suggests. These off-the-shelf solutions have been featured in 529 plans run by Fidelity in states such as California, Massachusetts, and New Hampshire. Other states, however, have customized the 529 plan’s investment lineup or the asset allocation within them. Such alterations can be based on suggestions from officials running other state assets, like a public-employee pension fund, or from consultants that the states hire to oversee or improve their investment choices. New York and Utah, for example, both have 529 plans featuring Vanguard funds, but their investment lineup is different from that in the Vanguard 529 College Savings Plan, a nationally marketed plan based in Nevada. Vanguard’s Nevada plan features three tracks of age-based options that vary their approaches to satisfy college A 529 plan usually starts with a Request for Proposals; a state government asks moneymanagement firms to bid to run its 529 plan assets. The RFP lists its 529 plan requirements, and firms submit proposals outlining exactly how they would run the plan’s assets. In March, California issued a 148-page RFP for its ScholarShare 529 plans, giving money managers a chance to win the state’s contracts away from Fidelity, California’s 529 program manager since 2006. After asset managers submit their bids, the state selects a winner and negotiates a management contract. Some of these contracts have relatively long terms—five years or more, 45

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