Morningstar has announced that they will be changing their 529 plan rating system in October 2020.
New Rating System Drops Consideration of Past Performance
The new rating system shifts from using historical performance toward a more forward-looking rating system.
The current rating system is based on five dimensions that Morningstar calls pillars. The new rating system will drop the Performance pillar, leaving just four pillars: People, Process, Price and Parent. The weightings for the four pillars will be 30% except for Parent, which will be weighted 10%.
Morningstar argues that the four remaining pillars are better predictors of future performance net of fees. They will no longer consider historical performance in their ratings analysis.
But, Savingforcollege.com has found that 3-year and 5-year performance ratings tend to be fairly stable, especially with regard to the top-ranked 529 plans. Savingforcollege.com’s 5-cap rating system evaluates 529 plans along four main dimensions: performance, cost, features and reliability. Savingforcollege.com continues to provide separate performance ratings for 529 plans.
Use our Financial Aid Calculator to help evaluate how your 529 plan could impact financial aid.
New Analyst Ratings Will Ignore State Tax Breaks
Morningstar also announced that they will no longer consider state tax breaks in their analysis ratings, but will continue to mention them in the written narrative. They say that more than half of 529 plan savers do not benefit from state tax breaks, with 42% living in states with no state income tax or state income tax break and 12% receiving the state tax break for investments in any state’s 529 plan.
This is in contrast with Savingforcollege.com’s approach, which involves maintaining separate 5-cap ratings for state residents and non-residents to reflect the inclusion and exclusion of state income-tax breaks and other benefits for state residents.
Other Changes in Morningstar’s Rating System
Morningstar is also implementing several cosmetic changes, such as switching from a 3-point rating system (positive, negative and neutral) to a 5-point rating system (high, above average, average, below average and low). They are also revealing the point thresholds for their scoring methodology, with Neutral, Bronze, Silver and Gold assigned based on half-point thresholds from 2.5 to 4.5 and Negative assigned to point ratings below 2.5.
Other changes include:
- Parent Pillar. The Parent Pillar will be based solely on the evaluation of state oversight. The assessment of program and investment manager stewardship will be included in the People Pillar. The evaluation of state oversight considers the insulation of state oversight from political turmoil, regulatory compliance, and the engagement and alignment with savers.
- People Pillar. The People Pillar considers investment and program manager experience and stability, as well as key-person risk.
- Process Pillar. The Process Pillar considers plan adherence to industry best practices, such as the investment philosophy behind investment options, whether there is a well-defined investment process and performance objectives, suitability of investment options for different types of college savers, and the plan’s approach to risk management and diversification.
- Price Pillar. The Price Pillar will consider fees without regard to the distribution channel (advisor-sold vs. direct-sold) or the investment management strategy (active vs. passive). Morningstar will no longer compare advisor-sold plans to just advisor-sold plans and direct-sold plans to just direct-sold plans, but rather every plan to every other plan. This change will likely lead to downgrades of advisor-sold and actively-managed plans, even if they are the least expensive option within their channel and investment management strategy. .
There will be special emphasis on age-based and target-enrollment date investment options, since they are the most popular investment options among college savers.