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Why Some 529s Took a Hit

Christine Benz

Christine Benz: Hi, I'm Christine Benz from Morningstar. Morningstar has just come out with its annual 529 Best and Worst study. I'm here today with the study's author, Greg Brown. Greg, congratulations on the study. I know it was a lot of hard work.

Greg Brown: Yes, it was. This year was particularly difficult analyzing these plans.

Christine Benz: Well, let's talk about it because 529s have been in the news recently. Some of the plans have really run into trouble, so can you outline what the big problem spots have been for some of these plans?

Greg Brown: One of the biggest issues that were in 529s this year was overly aggressive age-based options.

Christine Benz: So, Greg, what does that mean, age based?

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Greg Brown: Well, age-based options are options that an investor can put in an appropriate age for a child's account. So an investor with a younger child will be pretty equity heavy in the beginning and then it will transition slowly to cash and bonds towards the end or when a beneficiary is approaching college age.

Christine Benz: So, in a way it's similar to the target-date mutual funds that have gotten so popular, but there are some crucial differences. What do you think is the difference?

Greg Brown: Yeah, there are some big differences. Actually, up until the target date whether it's retirement or getting into college, the structure is very similar in that they start off with equities and transition smoothly to cash and bonds, but it's at that target date that really the plan's structure is different.

For target-date retirement, you've got 20, 30 or more years that you have to live on those assets. There are some options for retirees, you know, changing your lifestyle, reducing your expenses if you happen to be in an epic bear market when you retire.

Now, contrast that with college savings, you've got only, most parents hope, only a four-year period of drawdown, and so it's critical that you have very little equity exposure because you just don't have time to recover.

Unlike retirement, you don't have many options. College expenses are going to be what they are. They are not flexible. Most kids want to go to college when they graduate high school, so you don't have the date to push around.

There really are some crucial differences between target-date retirement and college age-based options even though on the surface they look very similar.

Christine Benz: So, it sounds like another issue with some of these plans is that there was only one age-based option for a given age. It was love it or leave it. If you like this asset allocation, this is what you get. You didn't have moderate, conservative, aggressive options within a given age.

Greg Brown: That's correct. A good number of plans did have those sorts of three age-based options, but an equal number didn't. They only had just the one age-based option that was potentially too bold for some investors that they 20 up to 50 percent in equity for a beneficiary close to college or in college. That's a problem when you don't get investors a choice to match their risk tolerance with potential drops in asset values.

Christine Benz: So, it's sound like an addition to having overly aggressive asset mixes, some of the plans had company specific problems. Can you outline a few of those? What went wrong with individual plans and some of the providers they were using?

Greg Brown: The big news this year was from Oppenheimer Funds. They had a number of domestic fixed-income products that they used. Oppenheimer actually has nine plans in five different states, and they used Oppenheimer Core Bond OPIGX in many of those 529 plans. That actual fund lost over 35 percent in 2008. So, substantial losses and the plans also had exposure to other Oppenheimer domestic fixed-income funds that also fell hard in 2008.

Christine Benz: Including some funds that were supposed to be government bonds or had government in their names but those still lost a lot of money, too.

Greg Brown: Yes, that's right. Yeah, those were in the red and they significantly lagged their peers. It was a problem because investors were expecting their child is about to go to college. They had it in what they thought were stable investments, you know, core bond, and those were some big problems last year.

Christine Benz: So, Greg, what if I have one of those Oppenheimer plans? What should I do? How do I know whether I should hang on or get rid of it?

Greg Brown: Well, those plans are definitely a unique case. I think investors should take a good hard look at those plans. A good place to start is our 529 home page. Each plan is a little bit different. Each plan had varying degrees of exposure to Oppenheimer Core Bond.

Each state has reacted differently. Illinois, for example, has reacted rather quickly. In early January they removed Core Bond and they addressed it with a letter. Some states waited until March 30th until coming out with what they are going to do.

Some of the other things to look for, for these Oppenheimer plans: is money still in the Oppenheimer Core Bond, existing money? A lot of them have stated that they have removed Core Bonds in offering, but some of them have existing money in Core Bond. Some still have exposure to Oppenheimer Limited-Term Government OPGVX which was part of the same management team and took some of the same bets as Oppenheimer Core Bond.

And the other thing to look for is some of the contract issues. Oregon, for example, their contract is coming due at the end of this year, and there is a big question mark of whether Oregon is going to renew that contract. There's no question they've caused a good deal of headache. There's a recent lawsuit from Oregon suing Oppenheimer for the losses.

So, it's important to really understand, are these plans how much money do you have in the existing plans and how they look going forward.

Christine Benz: OK, Greg, thank you. That's helpful advice and congratulations on the study.

Greg Brown: Thank you.

Christine Benz: Thanks for watching. I'm Christine Benz.