Morningstar 529 Ratings Misguide Investing Public

Kansas State Treasurer Ron Estes

Kansas State Treasurer Ron Estes

By Kansas State Treasurer Ron Estes

Morningstar Inc., a firm known for its ratings of mutual funds, began trying to evaluate 529 college-savings plans 10 years ago. Since then, the company has attempted to revise their approach for rating higher education savings plans, but blatant inconsistencies continue to remain in its methodology.

State Treasurers built the Kansas 529 program to include multiple investment options and low fees to provide Kansans and out-of-state investors with choices to accommodate their needs.  Yet, Morningstar’s methodology for evaluating 529 plans places more emphasis on account fees regardless of the better performance and services offered, which sometimes come with additional cost.

The Morningstar College-Savings Plans Industry Survey, released recently, is a prime example.

Within the report, portions of the Kansas 529 Program received unfavorable ratings, and other portions were left out completely. This alone wouldn’t be as problematic if it weren’t for the lack of transparency, subjective versus objective ratings, and series of contradictions associated with the research methodology used to evaluate our state’s program.

Morningstar currently rates plans based on five “pillar” scores for process, performance, people, parent, and price, but their recent report provides no transparency into how the pillar scores are derived or weighted to come up with the overall rating. While it’s understandable that the process, people and parent pillars may be ranked subjectively, the evaluation of price and performance should be completely quantitative and their methodology disclosed similarly to Morningstar’s practice with individual mutual funds. When Morningstar rates a mutual fund they provide a detailed analysis explaining how they rated each of the five pillars.  No detail for how they assessed each of these factors has been provided with this college savings plan survey.

This lack of transparency leaves us wondering why their evaluation focuses on certain aspects of a plan rather than assessing the whole picture.

For example, Morningstar penalized Kansas plans for not having the absolute lowest fees in the industry, but neglected to consider annual account maintenance fees charged by each of the “gold” rated plans. Kansas plans don’t charge a dime for annual fees to any investors.

Morningstar’s misguided bias towards ‘low fees’ also fails to account for the benefits investors obtain when working through an actively-managed 529 account.

Even after the Schwab 529 Plan created a new suite of passive investments to lower costs, Morningstar chose to give the plan a negative rating on price because it also includes higher priced options. These options are appropriate choices for some investors who may prefer the support of financial consultants, actively-managed investments, or more aggressive investments.

What I find most troubling with the report is the blatant contradictions within the rankings of each 529 plan.

After comparing the overall rankings amongst the states, I am disappointed that plans with the same or even worse pillar scores have received better overall ratings than Kansas 529 plans.

For example, plans sponsored by Maine, Nevada, Ohio, Oklahoma, Vermont, and Schwab 529 all received identical pillars ratings with the exception of performance where the Schwab 529 received a higher ranking.

But the Schwab 529 plan unfairly received a negative overall rating, while the others were given a neutral rating. If anything, performance net of fees should be weighted more heavily than the other pillars.

There are more inconsistencies.

Both Virginia 529 inVEST and Illinois Bright Directions received identical pillar scores as Learning Quest, but they received a Bronze overall rating while Learning Quest was rated neutral.

Another bias in Morningstar’s ratings is that they are more positive on a plan’s price and performance rating if the state offers a large tax deduction only for residents who are restricted to using that state’s plan.  Kansas has generously chosen to extend its tax deduction to KS residents who choose any state’s 529 in what the industry calls “tax parity.”  Kansas passed tax parity in response to the industry’s criticism that favoring only the in-state plan dampens competition.  I believe competition forces us to continuously work to improve our plan. Morningstar should stick to evaluating investments and leave state tax policy to another discussion.

These are just a handful of the many contradictions I’ve discovered within this report. Overall, the conclusions in Morningstar’s overall ratings are unclear, subjective and inconsistent, which is inexcusable for a company whose strength is analytics.

Kansas 529 Program account owners and the general public, who are all affected by these ratings, deserve to know how these evaluations are determined by Morningstar. Morningstar should follow a transparent standard and openly present the data. Otherwise, how do we know one state’s ranking isn’t purely based on an opinion or agenda?

Right now, the numbers just don’t add up.  Unless Morningstar fixes their methodology, they’ll continue to misguide the investing public, damage the reputation of 529 higher education savings plans, and discredit their own reputation.


Ron Estes is the Kansas State Treasurer, a member of the College Savings Plans Network Executive Board and the Midwest Regional Vice President for the National Association of State Treasurers in 2012 and 2013.