COLLEGE SAVINGS 101

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Opinion: The generification™ of 529 products
http://www.savingforcollege.com/articles/opinion-the-generification-tm-of-529-products-1043

Posted: 2017-3-21

by Brian Boswell

Financial Professional Content

This past weekend, the DC College Savings Plan transitioned plan managers from Calvert Investments, Inc. to Ascensus College Savings. As my alma mater, I'm sure Ascensus will be great for DC, offering best-of-breed investment options and lower fees. I think it's kind of a shame, though, as Calvert had one of very few truly unique products left in the 529 space, being the only socially-conscious plan out there. Plus, it had been the top performing 529 plan over pretty much every time period - one, three-, five-, and 10-year time periods - among both direct- and advisor-sold 529 plans in our composite rankings. High costs alone killed it.

529 savings plans are all starting to look the same. Sure, one plan might have a fund family that another one doesn't, but for the most part you've got a menu of diversified investment options comprised of age-based, target-risk, or static portfolios, all of which invest in mutual funds and ETFs, with a sprinkling of stable value and bank products. So what happened?

The 529 fee arms race

Personally, I blame the culture shift from active to passive investment management. Granted, it's based on study after study that has shown index funds outperform actively-managed funds over the long-term, and that lower fees result in better performance. This is nothing new, but with the rapid increase in popularity of ETFs in the late 1990's and really the first decade of 2000, there has been an arms race to the bottom in terms of who can get their index fund the cheapest the fastest.

The same thing has happened in the 529 savings market, with the average plan fee cut in half twice over since 1998. However, there is much, much more pressure to cut fees in the 529 space than in the retail markets, since contracts with states have expiration dates, so the program manager has to fight to keep their job every few years. That generally means cutting fees, improving investments, or throwing more marketing dollars to state constituents. Mostly it's cutting fees. This has been fantastic for consumers, because 529 plans are now, on average, less expensive than the average retail mutual fund despite being more expensive to operate.

Generification™ and 529s

The unintended consequence of the intense fee pressure and cultural shift towards index funds is a Generification™ of the 529 savings plan. They're all starting to look the same. That's not necessarily bad, because do we really need over 80 savings plans that do the same thing? With cars it makes sense: One person needs a truck for hauling their equipment or towing a trailer, and another a minivan to get their wife and triplets from point A to point B. But 529s aren't like cars or televisions.

The last I saw over 80% of assets in 529 savings plans were in age-based products, and it's a safe bet that some additional percentage of the remaining 20% isn't in age-based options because none are offered by the respective plan. A handful of plans out there actually are identical, and simply sponsored by different states. In this case, the states could just endorse a single plan, as Wyoming did in 2011, so the program manager can consolidate and lower costs. Producing separate plan documents for multiple identical plans never made sense to me.

Innovation in the 529 space

Business publications love the word, "innovation." Management applies it to everything. "Look at the new website we just launched: We created a fresh, innovative interface with a revolving banner!" News flash: Sprucing up your website isn't innovating, it's a necessity to remain relevant and provide strong service and support to potential and current plan participants.

True innovation is creating a 529 plan that offers a unique product or service. The Private College 529 Plan is truly unique. The Anti-Terror Fund that was in in the MOST Advisor Plan before it was shuttered was unique- it was terrible, but unique. So what more could be done in the 529 space to innovate? Drop the phobia around fees, worry less about what it will do to your rankings, and look at what could be done with higher-fee options. Costs can only go so low, so take a page out of the book of retail investment products:

  • Create a 529 product for high net worth investors. State sponsors are sensitive to the optics around catering to the wealthy, but everyone needs to save for college. High net worth investors benefit the most from 529 plans, since they receive the least financial aid and are in the highest tax bracket. But there is no "hedge fund" for college savers.
  • Create a plan that matches contributions from low-income participants. Forget about state matching and grants: There is no reason the plan can't match contributions from low-income participants, funding the match with plan fees. Or offer free transactions or other services to low-income participants. Offer scholarships or partner with paid scholarship service to offer free services for plan participants. Offer reduced plan fees for low-income savers.
  • Look to the oft-vilified variable annuity (VA) marketplace for inspiration. Stick with me, I know VAs are often (and often rightly) maligned, but there are some good things about them, too. In particular, many VAs offer an insurance wrapper to guarantee the original investment's principal, or a minimal investment return. This is something that would be ideal in the 529 space – where you have risk-averse investors and a shorter time horizon – and there is already demand for it. I've been asked multiple times by several wirehouses for a 529 savings product with a guarantee. Sure, it would cost more, but it would be incredibly popular, and provide peace of mind to investors that understand they're paying for that assurance. The challenge would be finding an insurer, pricing the guarantee appropriately, and creating the appropriate disclosure.
  • Look to the structured products marketplace, which hasn't quite taken off in the United States, but has grown dramatically overseas, becoming a multi-trillion dollar market. Structured products match a specific return profile to the investor using a combination of zero coupon bonds and equity options. Maybe there's a way to structure something similar by creating an investment pool each year using a combination of the college inflation index and market returns to obtain a specific return at a known level of risk.

Source: UK Structured Products Association

They can't all be winners

This isn't to say these are all great ideas, but more to point out that there is a lot more the 529 space could offer investors if it weren't handcuffed by an arms race to be the lowest-cost provider. Every plan can't be the cheapest option, because not every plan has the assets to make it work economically. So I encourage plan sponsors and managers to look to other savings and investment products to see what might be applied to your own businesses. Especially for plans that still have assets under $500mm, doing something novel could be the difference between long-term viability and a slow death to low-cost competitors.


"Opinion" articles are just that: The opinion of our authors. The content is the sole representation of the opinion of the author and does not necessarily reflect the views of Savingforcollege.com, its affiliates, or sponsors.

Financial Professional Content

This past weekend, the DC College Savings Plan transitioned plan managers from Calvert Investments, Inc. to Ascensus College Savings. As my alma mater, I'm sure Ascensus will be great for DC, offering best-of-breed investment options and lower fees. I think it's kind of a shame, though, as Calvert had one of very few truly unique products left in the 529 space, being the only socially-conscious plan out there. Plus, it had been the top performing 529 plan over pretty much every time period - one, three-, five-, and 10-year time periods - among both direct- and advisor-sold 529 plans in our composite rankings. High costs alone killed it.

529 savings plans are all starting to look the same. Sure, one plan might have a fund family that another one doesn't, but for the most part you've got a menu of diversified investment options comprised of age-based, target-risk, or static portfolios, all of which invest in mutual funds and ETFs, with a sprinkling of stable value and bank products. So what happened?

The 529 fee arms race

Personally, I blame the culture shift from active to passive investment management. Granted, it's based on study after study that has shown index funds outperform actively-managed funds over the long-term, and that lower fees result in better performance. This is nothing new, but with the rapid increase in popularity of ETFs in the late 1990's and really the first decade of 2000, there has been an arms race to the bottom in terms of who can get their index fund the cheapest the fastest.

The same thing has happened in the 529 savings market, with the average plan fee cut in half twice over since 1998. However, there is much, much more pressure to cut fees in the 529 space than in the retail markets, since contracts with states have expiration dates, so the program manager has to fight to keep their job every few years. That generally means cutting fees, improving investments, or throwing more marketing dollars to state constituents. Mostly it's cutting fees. This has been fantastic for consumers, because 529 plans are now, on average, less expensive than the average retail mutual fund despite being more expensive to operate.

Generification™ and 529s

The unintended consequence of the intense fee pressure and cultural shift towards index funds is a Generification™ of the 529 savings plan. They're all starting to look the same. That's not necessarily bad, because do we really need over 80 savings plans that do the same thing? With cars it makes sense: One person needs a truck for hauling their equipment or towing a trailer, and another a minivan to get their wife and triplets from point A to point B. But 529s aren't like cars or televisions.

The last I saw over 80% of assets in 529 savings plans were in age-based products, and it's a safe bet that some additional percentage of the remaining 20% isn't in age-based options because none are offered by the respective plan. A handful of plans out there actually are identical, and simply sponsored by different states. In this case, the states could just endorse a single plan, as Wyoming did in 2011, so the program manager can consolidate and lower costs. Producing separate plan documents for multiple identical plans never made sense to me.

Innovation in the 529 space

Business publications love the word, "innovation." Management applies it to everything. "Look at the new website we just launched: We created a fresh, innovative interface with a revolving banner!" News flash: Sprucing up your website isn't innovating, it's a necessity to remain relevant and provide strong service and support to potential and current plan participants.

True innovation is creating a 529 plan that offers a unique product or service. The Private College 529 Plan is truly unique. The Anti-Terror Fund that was in in the MOST Advisor Plan before it was shuttered was unique- it was terrible, but unique. So what more could be done in the 529 space to innovate? Drop the phobia around fees, worry less about what it will do to your rankings, and look at what could be done with higher-fee options. Costs can only go so low, so take a page out of the book of retail investment products:

  • Create a 529 product for high net worth investors. State sponsors are sensitive to the optics around catering to the wealthy, but everyone needs to save for college. High net worth investors benefit the most from 529 plans, since they receive the least financial aid and are in the highest tax bracket. But there is no "hedge fund" for college savers.
  • Create a plan that matches contributions from low-income participants. Forget about state matching and grants: There is no reason the plan can't match contributions from low-income participants, funding the match with plan fees. Or offer free transactions or other services to low-income participants. Offer scholarships or partner with paid scholarship service to offer free services for plan participants. Offer reduced plan fees for low-income savers.
  • Look to the oft-vilified variable annuity (VA) marketplace for inspiration. Stick with me, I know VAs are often (and often rightly) maligned, but there are some good things about them, too. In particular, many VAs offer an insurance wrapper to guarantee the original investment's principal, or a minimal investment return. This is something that would be ideal in the 529 space – where you have risk-averse investors and a shorter time horizon – and there is already demand for it. I've been asked multiple times by several wirehouses for a 529 savings product with a guarantee. Sure, it would cost more, but it would be incredibly popular, and provide peace of mind to investors that understand they're paying for that assurance. The challenge would be finding an insurer, pricing the guarantee appropriately, and creating the appropriate disclosure.
  • Look to the structured products marketplace, which hasn't quite taken off in the United States, but has grown dramatically overseas, becoming a multi-trillion dollar market. Structured products match a specific return profile to the investor using a combination of zero coupon bonds and equity options. Maybe there's a way to structure something similar by creating an investment pool each year using a combination of the college inflation index and market returns to obtain a specific return at a known level of risk.

Source: UK Structured Products Association

They can't all be winners

This isn't to say these are all great ideas, but more to point out that there is a lot more the 529 space could offer investors if it weren't handcuffed by an arms race to be the lowest-cost provider. Every plan can't be the cheapest option, because not every plan has the assets to make it work economically. So I encourage plan sponsors and managers to look to other savings and investment products to see what might be applied to your own businesses. Especially for plans that still have assets under $500mm, doing something novel could be the difference between long-term viability and a slow death to low-cost competitors.


"Opinion" articles are just that: The opinion of our authors. The content is the sole representation of the opinion of the author and does not necessarily reflect the views of Savingforcollege.com, its affiliates, or sponsors.

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