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Rating:Will 529 Plans Be the Salvation of the MF Biz? Not Rated 0.0 Email Routing List Email & Route  Print Print
Tuesday, April 09, 2002

Will 529 Plans Be the Salvation of the MF Biz?

by: Tony Pennino

It has not been a good couple of years for fund sponsors. The financial markets in general has been turbulent, and mutual fund sales have been flat. Still, fund marketing execs across the country are looking for the next big thing, and many have pinned their hopes on 529 plans. But are 529 plans a boomtown or a Potemkin Village?

It is common to compare 529s to that other product that gained a name from the tax code -- 401(k)s. Yet, the sustained 401(k) boom was a bit of a mirage in and of itself. Of course, there are great success stories like Fidelity and Vanguard, but there are also tales of firms slinking off in defeat. Only a relative handful of the 600 or so fund sponsors in existance have any meaningful marketshare in the 401(k) system.

It is likely that the 529 business will follow a similar pattern to the 401(k) business. Though we are still in the infancy of the 529 era, it will mature as the 401(k) market has. And a few firms will do extremely well in this space, but not a lot and certainly not all.

"The marketing guys are out there whooping 529 plans up. The 529 is a nice addition, but it is not going to be the big thing everyone thinks it will be. It is not a universal salve," Geoffrey Bobroff, president of Bobroff Consulting, stated in a conversation with the MutualFundWire.com. "The last couple of years have been rough. There have been declines in staffing, declines in the number of funds. The industry is still trying to reconcile that and is asking itself, 'Will there be a third down year? What will the long term affects be?' It is natural to try and find something that will show growth. The marketing side of the industry needs to do what it can."

As Bobroff opines, 529 plans will not be a universal salve. And there are a number of reasons for this.

First, the 529 plan does not answer a universal need the way a 401(k) plan does. With a 401(k) plan, everyone is looking forward to their retirement. With regard to 529 plans, not everyone has children. And for everyone who has children, not all of them get sent to college (less than 50 percent of those eligible for college go). And for all who get sent to college, many go to a state institution that is not that expensive. And for all of those parents who send their children to a private university, not all need assistance with paying for the education. And some parents think the children should work their through school. Add to that the fact any assets in a 529 subtract from potential monies a student might receive through financial aid. Yada yada yada. Simply put, the potential audience for 529 plans simply is not as big as the audience for 401(k) plans.

Second, individuals do not understand what a 529 plan is. The investing community needs to be educated on what they are. 401(k) plans had the advantage of having an employer explaining to a large group of employees at one time what a 401(k) plan is. With a 529 plan, the battle has to be fought one investor at a time. And there are a number of products trying to capture attention in this space. "There are a number of meaningful products out there such as Educational IRAs and the Uniformed Gift of Minors Act that might be more suitable for some individuals," Bobroff stated.

Bobroff also explained that the 529 plan is an extremely intricate complex entity. He predicted that states would soon be splintering their services, potentially seeking an "unbundled" approach to vendor selection. "This could really create an interesting dynamic in the next couple of years," he stated.

The consultant also contended that for 529 plans to work in attracting more investors that something would need to be done about pricing. "They need to be competitively priced for the broker channel." Plus, he added, Congress -- following last year's tax legislation -- is in no position to offer new tax incentives for those looking to invest in 529 plans.

He is also concerned about distributions. "When you have more than one vendor, then the reporting at distribution time becomes very complicated. Will they get it right? Will you get it right? The ICI has just filed a letter with the IRS on reporting requirements in 529 plans. Again, this is a new product, so not all the kinks have been worked out yet."

Yet another concern for Bobroff is stable value. "Having a stable value product in a 529 plan seems to be growing in popularity. It is certainly something that state treasurers will want, but I am not so certain that state treasurers are quite so savvy when it comes to this product. A stable value offering is difficult to support in an open architecture. And stable value is not something the individual is going to understand particularly well."

So, what opportunities are available in this marketplace?

Well, as with everything, else the firms that are the most flexible and quickest to respond to the needs of the customers will do the best. First to market, though, is not necessarily a criteria. On the 401(k) side, Fidelity was near the end of the line of firms entering that niche. It certainly learned from other firms' mistakes -- and successes -- and built a very successful business by defining the terms of the fight (daily valuation versus quarterly, mutual funds versus separate accounts or commingled funds).

There is also a lot to be said for providing the back office and administrative systems for 529 plans without getting involved with headaches of asset management. PFPC appears to be building a successful business by providing administrative support to a number of firms that service 529 plans. State Street has recently entered into an alliance with three other firms including Prudential wherein State Street -- which is an asset manager in its own right -- will take on the back office duties. Back during the California gold rush, maybe 1 in 100 prospectors struck gold. But all 100 needed a pick axe and a shovel. By providing the back office support, firms will be taking on the role of the shovel salesmam.

A handful of firms will provide the kind of investment vehicles that clients will crave. These firms will leverage their broker/dealer channel well in getting the word out in a simple, easy-to-understand format. The ability to distinguish between other products will be a key in success.

So, there it is. Are 529 plans the land of milk and honey? Probably not. But there is still opportunity in the space for a few firms to excel. As Bobroff stated, "The next two years will be highly volatile. The strong will survive, and the weak will wither away."

Related Story:

  • 529 Does Not Equal 401k; February 27, 2002. 

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