Companies add conservative investment options while equities rebound

Talk about a day late and more than a few dollars short.

Financial services companies started pushing state-sponsored 529 college savings plans five years ago without giving much thought to a market downturn. As a result, many investors with plans anchored by equities have been hammered over the past two years.

Now, however, just as financial services companies are riding to the rescue with more-conservative 529-plan investment options, the market is showing signs of a sustained revival.

“You know you’ve reached the bottom of the market when you start seeing products like this,” says Andrew Tapparo of Tapparo Capital Management, an adviser in Topsfield, Mass., that oversees about $22 million.

“People may rush into them today. But what happens if we see a couple of years of good market returns? You can’t help but think they are going to drop them,” he says.

Adding complexity

Bad timing or not, the rush is on.

Alliance Capital Management LP in New York last week added what it calls a “stable-value investment fund” to the 529 program it manages for the state of Rhode Island.

Stable-value funds aim to maintain an investor’s principal and earned interest. They often are created by combining bond portfolios with wrapper contracts issued by insurance companies and banks.

Bank of America Corp. of Charlotte, N.C., plans to include a similar option when it takes the program it runs for the state of South Carolina national next week.

Fidelity Investments in Boston and T. Rowe Price Group Inc. in Baltimore also are considering plans to provide a guarantee against losses, InvestmentNews has learned.

After a year in which many investors saw double-digit losses in their 529 accounts, many advisers welcome the addition of a guaranteed option. Some, however, wish it had come along sooner.

Judy C. Miller, a principal in College Solutions, an Alameda, Calif., advisory firm that specializes in college funding, likes the guaranteed-investment option. But she worries that the proliferation of the option will only add to the complexity of picking a 529 program.

“The competition among states to have the flashiest program runs the risk of confusing people to the point where they throw their hands up in the air and say, `This simply isn’t worth it,”‘ she says.

That isn’t likely.

Despite the recent volatility in the stock market, 529 plans are selling like crazy. At the end of last year, assets in the plans totaled $7.1 billion – more than double the amount a year earlier, according to Cerulli Associates Inc. in Boston.

Furthermore, assets in such plans are expected to surpass $50 billion by 2006, Cerulli predicts.

Every state, plus the District of Columbia, either offers a 529 program or intends to do so.

Pushing hard

TIAA-Cref in New York, the nation’s largest 529 provider, also was one of the first to bring a guaranteed-investment option to college savers.

Since July 2000, it has added such an option – which guarantees principal and a minimum rate of return of 3% a year – to 529 programs in eight of the 12 states for which it manages such assets.

“We didn’t introduce these options based on any recent volatility we’ve seen in the market,” says Michael Noone, vice president of tuition financing at TIAA-Cref. “But clearly we have seen a greater flow into the guaranteed option over the past six to 12 months.”

Earlier this year, TIAA-Cref also began shifting some of its 529-plan assets away from growth stocks to more-conservative investments. The move, says Mr. Noone, is being driven in part by the demands of the states sponsoring the plans.

“I don’t know if I want to suggest that it’s because the states have mandated that we go and do this,” he says. “It’s a collaborative process.”

But Lynn Allen, director of public markets at AEGON Institutional Markets, a Louisville, Ky.-based unit of Dutch insurer AEGON NV, says many states indeed are pushing for more-conservative options among college savings programs – and pushing hard.

Changed attitude

Not that you can blame them: The Maine Equity Aggressive Growth portfolio, run by Houston’s AIM Management Group, lost 29.3% last year, compared with a 11.8% loss for the Standard & Poor’s 500 stock index and a 20.9% loss for the average growth fund.

Arizona’s SM&R Alger Small Cap fund, run by Securities Management and Research Inc. in League City, Texas, meanwhile, lost 30% in 2000.

Of the seven states that issued requests for proposals for 529 plans in the last six months of 2001, five specifically asked that a stable-value option be part of the proposal, Ms. Allen says.

“The states saw that a lot of people placed a high premium on protecting their principal or protecting their savings from loss,” she says.

AEGON Institutional Markets, a leading provider of stable-value products, is in final negotiations with four unnamed 529-plan providers to devise plans to add a stable-value component to their programs.

It is in preliminary discussions with two or three others, says Ms. Allen.

The sudden interest in stable-value funds represents a change in attitude among 529-plan providers.

“I was met with some resistance initially,” concedes Ms. Allen. “The providers had other priorities. The main one being getting their 529 infrastructures up so they could start selling these programs as soon as possible.”