Kansas gets a failing grade on part of a program to help parents save for their children’s college education, one of the nation’s leading independent financial research firms says.
Citing high investment-management fees, Morningstar Inc. gave a “negative” rating to the biggest of the three investment plans offered through Learning Quest, the education savings program administered by the state treasurer’s office.
The “plan’s steep price tag detracts from its appeal,” the Morningstar report said.
State Treasurer Ron Estes says that’s not fair and that analysts need to change the way they score college-savings programs.
“I’m not very happy about Morningstar,” he said Tuesday, adding that he thinks the company’s methodology pays too much attention to fees and not enough to overall investment results.
The so-called 529 plans – named for a section of the federal tax code – let parents and others invest money that earns tax-free interest to be withdrawn later to pay for college expenses. Most states offer similar college-saving plans.
Investments can be sold directly to the public or through financial advisers.
In general, direct-sold funds have lower fees because they don’t have to pay a sales fee, or “load” to the adviser, said Kathryn Spica, the analyst who prepared Morningstar’s report.
Morningstar’s report was particularly critical of an option of the Kansas program: direct-sold investments offered through the Charles Schwab & Co. brokerage firm.
The Schwab funds carry management fees of 0.65 to 1.39 percent for actively managed investments and 0.55 percent for funds linked to market indexes, according to the report.
“Indeed, this plan is pricey when compared with the majority of its direct-sold peers and is even more expensive than several adviser-sold plans,” the report said.
Estes said that even after accounting for the higher fees, the earnings from the Schwab plan were higher than for many other funds with lower fees.
He said Kansas could improve its rating by offering fewer and cheaper investment options, but that would limit customer choices, and he doesn’t want to do that.
The Morningstar report acknowledged that returns from the Schwab plan have “mostly surpassed their peers.”
However, the report concluded that it will be increasingly difficult for the plan to stay ahead of others.
“Other plans have reduced fees in recent years, creating a tougher hurdle going forward,” the report said. “Given lower-priced options, college savers should look elsewhere.”
Spica said part of the problem could be that Kansas has taken the unusual – possibly unique – route of having two management firms handle its 529 investment program.
The state contracts with American Century Investments to directly manage two of its Section 529 investment plans, called Learning Quest Direct and Learning Quest Advisor. The direct option is for people who want to manage their own funds and the adviser option is for those who want a more guided investment experience.
This year, Morningstar downgraded Learning Quest Direct from a “bronze” rating, a mild recommendation, to “neutral.” The company did not rate Learning Quest Advisor.
The third option among Kansas 529 plans is the one Morningstar rated negative, which is managed by American Century and distributed by Schwab through its national brokerage network under a subcontracting arrangement.
Estes said the major reason Kansas decided to offer the plan through Schwab was to give its investors more choices of who to work with.
It makes it easier for customers who are already working with Schwab on retirement or other investment plans, he said.
About 55 percent of the assets invested in Kansas’ 529 plans are in the Schwab program, said Scott Gates, who directs the plans for the state.
But most of the assets in Schwab are from out-of-state investors attracted by the company’s national marketing efforts, he said.
About 95 percent of the Kansas residents who invest in the 529 program choose either Learning Quest Direct or Learning Quest Advisor, he said.