Morningstar has announced a new, streamlined framework for rating 529 plans that will no longer differentiate between between advisor-sold and direct-sold plans or between active or passive investment options when determining price ratings.
“Because we’re aiming to identify plans that will outperform peers, and price is a strong predictor of future performance, our enhanced methodology will remove the distribution channel and active/passive/blend distinctions and instead will compare all plans’ fees versus one another,” explains analyst Madeline Hume, on the Morningstar website.
Price will be one of four variables in Morningstar’s new 529 rating system that will debut this October. It will account for 30% of a plan’s rating as will “Process,” which gauges asset allocation and the glide path for age-based portfolios, and “People,” which measures the talent, tenure and resources of money managers and program managers.
A “Parent” rating, gauging only a plan’s state stewardship rather than also the caretaking by program and investment managers, which is the case currently, will account for 10% of 529 plan ratings.
The new rating system will eliminate a separate pillar for performance because Morningstar has found that the four previously mentioned elements — process, people, price and parent — “are the best predictors of future performance of investment strategies, net of fees.
It will also omit consideration of state tax benefits because “every saver’s tax situation is unique, depending on state residency, income level and size and frequency of contributions,” according to Hume, though the topic may be included in analysts’ discussions.
All four pillars will be rated on score of 1 to 5, with five indicating the highest score for all but the Price pillar. In that case a score of one will be the best rating. Current scoring for pillars ranges is on a 1 to 3 scale.
Once the new scores are added up, plans will be assigned ratings of negative, neutral, bronze, silver or gold, though analysts will have some discretion to override these scores if they believe a different rating is justified.
“We’re setting clear expectations for gold, silver and bronze ratings; for a plan to earn these ratings, our research must convince us the plan both follows best practices and offers investments that will collectively outperform relevant peer groups after fees and accounting for risk,” Hume writes.
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