Mutual fund fallout should help 529 college fund savers

NEW YORK — There’s a silver lining for investors in 529 college savings plans amid the widening mutual fund probe: A broader selection of investments.

Investors have flocked to these state-sponsored plans after a 2001 tax law made qualified withdrawals free from federal taxes as long as the funds were used for education.

But as allegations that mutual fund companies engaged in market-timing and late-trading practices continue to unfurl, more states could drop the next tainted fund company from their lineup. The logical step for states: Hire more fund managers to reduce their risk, experts said.

Oregon was the first state to oust one of its college savings program managers, Strong Capital Management Inc., because of allegations that Strong had engaged in improper market timing. The state now says it is looking to bring in more fund managers to replace Strong and possibly adopt a multimanager approach.

Meanwhile, Wisconsin said it would look to add other mutual funds to its EdVest 529 savings plan to give investors options other than Strong, the program manager.

"We want to be able to offer two to three different fund families and pick the best of those fund families," said Michael Parker, executive director of Oregon’s college savings program. "Because that way you get the benefit of the best of breed of several different mutual funds, so you’re not relying on one company."

States may choose to add more fund families under a single plan, known as a multimanager platform, or can award more than one mandate. Maine’s NextGen College Investing Plan, for example, offers 16 investment options across four different fund managers. Nevada, on the other hand, offers six separate 529 savings plans.

Either way, adding more funds will give states diversification, experts said. That way, if one fund company falls out of favor, a state would be able to rely on its other funds and have the flexibility to hire and fire individuals funds across different fund families.

"I’m convinced that if we continue to see the upheaval in the fund companies, I think the states are going to have to look at multimanagers," said Troy Miller, founder of www.529directory.com, an information Web site on 529 plans. "It really does diversify your managers, so you’re not relying on one style."

Even before Oregon dropped Strong, the state had already opened up the plan by adding First American Funds. Other states are adding broker-sold plans. California, for example, is currently soliciting proposals from companies to serve as an investment manager for an adviser-sold 529 college savings plan.

"It might end up being a much more competitive marketplace for the firms involved," said Dan McNeela, an analyst at Morningstar Associates. "When you’re weighing the choice of one plan over another, you won’t feel as restricted to stay with one plan if the barriers to competition come down."