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Researching 529 Plans Made Easy

How to use Morningstar's new data to find the most appropriate options for clients.

Christina West, 07/12/2011

This article first appeared in the June/July 2011 issue of Morningstar Advisor magazine. Get your free subscription here. 

Analyzing 529 plans and their investment options for clients can be daunting, but new data and tools available in Morningstar Office make the task approachable. Advisors now have all the plan-level data necessary to determine whether an option is suitable for a client, and they can screen for plan investment options in similar ways that they shop for mutual funds.

Look Home, First
It's important first to take a look at the client's home-state plans to understand the potential tax breaks or other perks (such as Maine's $500 grant for newborns signed up before their first birthday).

Using data in Morningstar Office, advisors can check whether the client's home state offers tax deductions on contributions and whether those deductions are portable to plans outside of the home state (Exhibit 1).

A plan from any state nationwide may be appropriate depending on the tax benefits and the client's circumstances.

Then Head for the Top
Whether a client is staying in-state or looking nationally, advisors will want to start zeroing in on the highest-quality plans. Morningstar now provides analyst ratings on 54 of the largest 529 plans, representing more than 90% of the industry's assets. Morningstar's analysts have acquired an in-depth understanding of the investment lineups through bottom-up research on the individual funds that make up the 529 portfolios. Analysts also know many program managers well as a result of their work on Morningstar's Stewardship Grades for mutual funds. The 529 analyst ratings, therefore, are a holistic measure of a plan's potential for success. Analysts base their assessment on five areas: Program Manager, People (fund managers), Process/Portfolio, Performance, and Price. Analysts award plans a rating of "Top," "Above Average," "Average," "Below Average," or "Bottom."

The analysts' work is presented in the 529 plan reports, which are available in Morningstar Office and Principia (Exhibit 2). The plan reports are a great way to get a bird's-eye view of each plan. For age-based tracks (those all-in-one investments that automatically reduce exposure to equities over time), the reports also depict the plan's target equity allocation, or glide path, in an easy-to-understand graphic.

A Screen
To see the potential of Morningstar's new data, let's use the example of a client who is a New Jersey resident. A simple screen in Morningstar Office can find Top and Above-Average plans sponsored by New Jersey and by other states that are open to nonresidents (Exhibit 3).

Advisors can further narrow the results by specifying a single sales channel or considering only those out-of-state plans with a Top rating. Advisors can also screen for plans that include at least one age-based track or plans that offer a large menu of static options (so advisors can do their own portfolio construction). Other useful plan-level data points that can be screened for include:

  • Program manager
  • Plan inception date
  • Net assets-plan
  • Web address
  • Min/max total expense ratio
  • Min/max of various other asset-based fees
  • Enrollment and other flat fees
  • Min/max investment amounts
  • State tax deduction restrictions
  • Tax parity

Advisors can pull all these data points into a standard spreadsheet view (and export to Microsoft Excel) to compare plans at a glance.

Now, let's narrow the field in our example further to the New Jersey plans and those out-of-state Top plans with more than 10 static portfolios (Exhibit 4). Top-rated plans from this screen include:

CollegeAdvantage 529 Savings Plan
This direct-sold plan, run by the Ohio Tuition Trust Authority, offers a mix of passive and actively managed options, strong underlying managers, and a competitive fee structure. It features four age-based tracks, three of which are managed by Vanguard in a format similar to those available in other 529 plans. The fourth age-based track, designed by consultant to the plan Wilshire Consulting, mixes active and passive investment styles in a more diversified approach, including discrete allocations to high-yield bonds, inflation-protected bonds, and international equities. The track features active funds from Vanguard, PIMCO, Oppenheimer, and GE, which are also available as individual fund options. Planwide, fees range from 0.19% for a stand-alone Vanguard 500 Index fund to 1.04% for an Oppenheimer small-cap fund. The minimum investment is just $25.

American Funds is the program manager for this advisor-sold plan, and it features 24 individual options (with various share-class proliferations) from the fund company behemoth. Nearly all of American's taxable funds are available in the plan, spanning a wide range of domestic-stock, foreign-stock, and fixed-income offerings. Several are Morningstar Analyst Picks, our highest-conviction positive appraisal of an investment's aptitude for long-term success. Asset-based fees range from 0.64% to 1.22% on the A shares (and from 0.49% to a hefty 2.05% when considering all share classes), and typical loads of up to 5.75% may apply. The minimum initial investment remains approachable to most college savers at $250.

The Vanguard 529 College Savings Plan
This direct-sold plan's main disadvantage is its $3,000 initial investment hurdle. The plan features three cheap (0.25%) age-based tracks constructed around a fairly basic framework with allocation among five Vanguard funds that are all well regarded by Morningstar. It's worth noting that all tracks (even one labeled aggressive) take the equity allocation to zero by the beneficiary's enrollment year, though advisors have ample opportunity to construct a customized portfolio using 19 static allocation and individual fund options to arrive at a different equity mix. The options outside of the age-based tracks range in price from 0.25% to 0.55%.

Analyzing a Plan's Investment Options
Once you've narrowed the focus to a select group of plans, advisors must sift through all the investing options available to clients per residency and sales-channel restrictions. This is now easy to do using Morningstar's Availability and Sales Channel data points. Morningstar's database tracks more than 4,000 529 portfolios, each being available through a lone 529 plan (unlike a single mutual fund that may be available through several distribution channels). There are four 529 portfolio types:

  • Age-based fixed: Available as part of an age-based track. The plan will move the client through a series of distinct portfolios.
  • Age-based progressive: Available as part of an age-based track. The plan will adjust the allocation of the purchased portfolio over time.
  • Static allocation: Stand-alone investment in a fund-of-funds structure with an asset allocation that does not programmatically change over time.
  • Static: Stand-alone investment either wraps a single fund or holds individual securities (like stocks and bonds) directly.

Given the wealth of data now available at the 529 portfolio level, some advisors may choose to begin their research by screening for 529 investing options much like they do for mutual funds. Advisors can screen for the 529 options based on:

  • Morningstar category
  • Morningstar Ratings (overall, three-, five-, and 10-year trailing periods using the same methodology as Morningstar Ratings for mutual funds)
  • Portfolio data (drill down to fund- and stocklevel holdings, asset allocation, valuation ratios, style/region/country exposures)
  • Risk metrics (standard deviation, Sharpe ratio, upside/downside capture)
  • MPT statistics
  • Total expense ratios and all component fees (administration, distribution, program management, trustee, underlying fund fees)
  • Load and fee breakpoint schedules
  • Trailing- and calendar-year returns
  • Estimated net flows
  • Glide path (age-based track target asset allocation)

What's in a Name?
Unless the 529 portfolio is a simple wrapper for a strategy that is already offered in the mutual fund world, the name of a 529 portfolio may give little insight as to which funds or securities actually comprise it. In open-architecture plans, which allow program managers to hire multiple money managers, advisors can expect to see funds from different asset-management firms built into the fund-of-funds structure of the plan's static allocation and age-based options.

Take CollegeAdvantage's option named OH Coll Adv Advantage Age-Based 0-5. Looking at the name doesn't provide much insight into the investment style of the fund. But looking at its holdings reveals representation from Vanguard, Highland Funds, OppenheimerFunds, and PIMCO. After saving these holdings to an investment list, advisors can use their typical research procedures to further analyze the funds.

Some advisors may just want to do some comparison shopping at a higher level to assess the track record and risk profile of 529 portfolios. Advisors can screen for longer-term category-topping performance in just those plans they are considering (Exhibit 5), or they can cast a wider net by removing the Plan Name restriction. Be aware that 529 investment options have proliferated at a rapid pace in the past several years. (959 share classes were launched in 2010 alone, by Morningstar's count.) So, investment options worthy of consideration may not always come with very long track records.

Morningstar also provides comprehensive data on 529 portfolio fees. Use the Total Expense Ratio data point to understand the total asset-based fee for an investment option. Advisors can compare portfolios across plans to see whether the total numbers and component parts (such as program-management and underlying fund fees) seem fair.

More Ways to Research
Using Morningstar Office, advisors can always branch out from the data view to get a handle on the profiles of potential 529 investments by running Investment Detail, Investment Summary, or Quicktake reports or by generating a Growth or Rolling Return chart. Advisors can take a basket of 529 portfolios and run a traditional Morningstar X-Ray report to check how the asset allocation, region, and sector exposures balance out across a combination of investments. Running a Stock Intersection report can reveal concentrated exposure to particular securities.

The list goes on. Most of Morningstar's data and tools are now available for the 529 portfolio universe. What may have once seemed like an overwhelming research proposition has gotten a lot easier.

Christina West is a mutual fund analyst with Morningstar.

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