In 2016, Morningstar identified 33 plans that it believes to be best-in-class options, assigning these programs Analyst Ratings of Gold, Silver, and Bronze. These plans for the most part follow industry best practices, offering some combination of the following attractive features: a strong set of underlying investments, a solid manager selection process, a well-researched asset-allocation approach, an appropriate set of investment options to meet investor needs, low fees, and strong oversight from the state and program manager. These features improve the odds that the plan will continue to represent a strong option for investors. Gold-rated plans have all or a vast majority of these attributes. Silver- and Bronze-rated plans embody most of these qualities but often have some room for improvement.
Meanwhile, 27 plans earned Neutral ratings. These plans remain unexceptional, either because weaker aspects offset stronger ones or an element of uncertainty, such as an investment team change, clouds their prospects. Some Neutral-rated programs may hold appeal for in-state residents because of meaningful added benefits, such as local tax breaks, so investors should research their state's particular benefits.
Just three plans received Negative ratings in 2016. These plans generally lack compelling traits and have at least one major flaw that makes them worth avoiding. Nationwide, there are 84 529 savings plans, and these ratings represent 97% of assets invested in 529 plans.
This year, Morningstar upgraded six plans and downgraded six, compared with five upgrades and one downgrade in 2015. We also initiated coverage on two plans from Rhode Island and dropped coverage on two small, unexceptional plans: Nevada's Putnam 529 for America and Iowa's IAdvisor 529 Plan; both programs received Neutral Morningstar Analyst Ratings in 2015.
In general, the industry continues to take steps in the right direction, with a number of plans cutting fees, beefing up their asset-allocation resources and processes, or improving the quality of their investment lineups. This article focuses on this year's upgrades. Part two of this series publishes on Thursday and will detail the downgrades. In-depth analyses of all 63 plans under coverage
are located on Morningstar.com.
The Gold Standard
Virginia's direct-sold plan, Virginia529 inVEST received a notable upgrade, increasing to Gold from Silver. The plan's sensible approach and strong underlying manager lineup has long made it a compelling option for investors. With fee cuts over the last year, the plan also looks attractive from an expense standpoint, and it now represents one of the best choices available to college savers.
In partnership with an investment consultant, the plan's state administrators built the age-based options with a thoughtful asset-allocation approach. Unlike most plans that abruptly cut equity exposure by double-digit percentage points at various dates as the beneficiary ages, the track gradually reduces stock exposure, which limits the risk of shifting out of equities at inopportune times. The portfolios diversify into specialty areas often not found in 529 plans, such as emerging-markets debt and global REITs, and they use a practical approach in blending active and passive management, favoring index strategies in more-efficient pockets of the market. The plan's manager-selection process also sets it apart from competitors. It has used open architecture to its advantage, choosing best-in-class skippers from a variety of investment shops. It mixes inexpensive Vanguard index funds with well-regarded, actively managed strategies from firms such as American Funds, Dimensional Fund Advisors, and Franklin Templeton. The majority of the plan's assets reside in Morningstar Medalist funds, meaning the analysts believe they will outperform competitors over the long haul.
In 2016, Virginia cut the plan's program management fee by one third to 10 basis points, and it reduced expenses further by switching to cheaper share classes for some of its underlying funds. Investors can now buy the age-based options for an average fee of 0.43%, which is very reasonable considering the portfolios' significant use of actively managed strategies. Both residents and nonresidents will find plenty to like with this plan.
Virginia529 inVEST joins just two other plans that receive Gold ratings. Investors looking for low-cost, broad diversification should also consider Nevada's Vanguard 529 College Savings Plan, which uses all passively managed strategies. Although many plans have adopted a similar set of inexpensive Vanguard indexes, as the third-largest 529 plan by assets, this plan benefits from economies of scale. The plan has continued to share its cost savings with investors by cutting its program-management fee as it has grown. The most recent cut came in May 2016, when the age-based options' fee dropped to 0.17% from 0.19%.
Meanwhile, investors looking to build customized portfolios will find Gold-rated Utah Educational Savings Plan particularly appealing. The plan allows account holders to design their own age-based tracks using a wide array of investment options from Vanguard and DFA. Moreover, the standout oversight provided by Utah has resulted in multiple years of small but steady fee cuts for these well-regarded investment options. Most recently, reductions of 1 basis point or less in several portfolios result in age-based portfolios that now charge between 0.17% and 0.21%.
A New Silver-Rated Plan
Missouri's direct-sold MOST 529 plan received a notable upgrade in 2016, with a rating increase to Silver from Neutral. It's not often than a plan's rating jumps by two rungs, but a program overhaul made it possible here.
In an effort to leverage economies of scale and offer investors a single, best-in-class option, the state consolidated its advisor-sold plan (MOST 529 Advisor Plan) into this plan. In the process, it also cut fees on its age-based options by 5 basis points to 0.23% while also eliminating the $10 account maintenance fee, which can be particularly punishing to accounts with small balances.
The plan also improved its appeal for do-it-yourself investors. In addition to a set of index-based funds, the stand-alone lineup now includes five actively managed DFA funds; four replaced similar--but more expensive--Vanguard options. Overall, these changes reflect strong oversight and provide confidence that the plan will continue to be a top choice for investors.
Boosted to Bronze
Lastly, we upgraded four direct-sold plans managed by Fidelity to Bronze from Neutral. Increased familiarity with Fidelity's tactical asset-allocation approach as well as reduced fees on the plan's index-based portfolios spurred the upgrades.
In 2014, Fidelity introduced tactical management within its age-based track that invests in actively managed Fidelity funds. Fidelity lacked a public track record in the space, and it was afforded significant leeway in positioning the portfolios, creating uncertainty. While Fidelity still hasn't proved an ability to add long-term value with tactical moves, it has operated within fairly strict guardrails, making it unlikely that such moves will take performance meaningfully off track.
Meanwhile, the plan improved by slashing fees on its passively managed age-based track. Investors can purchase this track for an average fee of 0.15%, making it one of the lowest-priced age-based options available nationwide. Expenses on the plan's multifirm track also decreased, though fees for those options remain high.
In 2016, Morningstar assumed coverage on Rhode Island's advisor-sold CollegeBound 529 plan and its direct-sold CollegeBound Saver program. The state overhauled both plans in July 2016, replacing former program manager AllianceBernstein with Invesco and Ascensus. Invesco manages the plans' investments and distributes them nationally, while Ascensus serves as the program manager and recordkeeper.
Both plans offer one age-based track that follows a sensible asset-allocation approach, gradually ratcheting down stock exposure over time. The gradual shifts help college savers avoid the potential of locking in losses from making a big move out of equities after a market dip. The direct-sold plan invests primarily in well-regarded Vanguard and iShares index-based strategies, while the advisor-sold plan blends actively and passively managed strategies from Invesco with PowerShares exchange-traded funds.
The direct-sold plan offers extremely low fees for Rhode Island residents--the plan's primary investors--earning it a Silver rating. (Nonresidents should look elsewhere, because they must pay much higher fees than Rhode Islanders.) The advisor-sold plan's fees aren't as compelling, though they land below average compared with similarly sold peers that blend active and passive management. The plan receives a Bronze rating.
Morningstar Analyst Rating Inputs
Since 2012, ratings for 529 plans use the same scale as the Morningstar Analyst Rating for mutual funds. Both Analyst Rating methodologies consider the same five factors to arrive at the final rating, though the 529 ratings reflect the quality of the entire plan--not a single investment, as is the case for the fund rating. To arrive at an Analyst Rating for 529 plans, analysts consider:
- Process: Did the plan hire an experienced asset allocator to design a thoughtful, well-diversified glide path for the age-based portfolios? What suite of investment options is offered?
- People: What is Morningstar's assessment of the underlying money managers' talent, tenure, and resources?
- Parent: Is the program manager a good caretaker of college savers' capital? Is the state managing the plan professionally?
- Performance: Have the plan's options earned their keep with solid risk-adjusted returns over relevant time periods? How is the plan expected to perform going forward?
- Price: Are the investment options a good value?
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