Tomorrow s Scholar 529 Age-Based Portfolios Attractive option for college saving... connecting to the future Not FDIC Insured May Lose Value No Bank Guarantee INVESTMENT MANAGEMENT
Introduction The goal of a 529 account is simple: accumulate tax-free savings to pay the costs of a beneficiary s college education. A number of factors play a role in determining whether the account achieves this goal. The most important factor is the amount contributed, but the investment results achieved during the saving period also affect the outcome. The Tomorrow s Scholar 529 plan offers three distinct ways to invest: by age, by risk level and by custom-building portfolios for clients; each choice offers access to investments that feature some of the largest and most respected asset management firms. In this paper, Voya explores how the age-based portfolios of the Tomorrow s Scholar 529 program, which are managed by Voya Investment Management, seek to outperform college inflation through their investment strategy. Age-based portfolios: aimed at meeting client goals Not all 529 plans are managed the same, and Voya believes the differences can have a meaningful impact on achieving the plan s goals. Age-based means that the college saver s mix of investments changes as he or she ages, adjusting to maintain an age-appropriate mix of assets intended to optimize the portfolio s chances of successfully meeting its goals. To do this, Voya employs a unique approach to manage the factors that help drive return: The transition from wealth building to wealth preservation The mix of asset classes in the portfolios The mix of managers in the portfolios Careful management of investment risks The investment process of the Tomorrow s Scholar 529 brings all these factors together, seeking to help investors reach their goals. In this brochure we discuss how these decisions potentially contribute to achieving the portfolio s goals. 2
Managing the transition from wealth building to wealth preservation One of the primary investment decisions for a defined-horizon savings portfolio, such as a 529 plan, is how to transition from a focus on capital accumulation to a focus on capital preservation. The mechanism of this transition is known as a glide path. The glide path refers to the college saver s transition over time from an emphasis on equity investments in the early stages to an emphasis on fixed income investments in the later stages, as college age nears. The glide path reflects the changing risk tolerance of the average participant over time. The glide path of the Tomorrow s Scholar 529 Plan uses nine age-based portfolios. Voya believes these finer increments facilitate a smoother shift from equity to fixed income investments; what s more, they serve to help reduce the risk of losses during rebalancing periods, when the portfolios are in flux and might be susceptible to short-term disruptions of the normal return relationship between stocks and bonds. Nine age-based portfolios permit finer risk management distinctions Age 0-4 Age 5-8 Age 9-10 Age 11-12 Age 13-14 Age 15 Age 16 Age 17 Age 18+ Equity 95% 85% 70% 65% 50% 45% 35% 25% 10% Fixed Income 5% 15% 30% 35% 50% 55% 65% 75% 90% Large Cap Mid Cap Small Cap International Commodities Real Estate Intermediate Term Bond High Yield Bond Senior Loan TIPS Short Term Bond 3
A Glide Path Tailored for College Savers Voya s Multi-Asset Strategy and Solutions team (MASS) follows a glide path philosophy specific to college savings, in contrast to modeling the glide path as you would for a retirement savings plan. What does the Tomorrow s Scholar 529 glide path look like versus that of industry peers? To answer this question, Voya can utilize Morningstar 529 Research and Ratings. In 2014, Morningstar created new 529 peer group categories to help investors evaluate 529 plans and investment options. Age-based 529 portfolios are assigned to different peer groups based on the average equity exposure of a participant in the plan at specific age intervals. For example, if a plan participant has an average equity exposure >90% from ages 0-6, then the plan s age-based portfolios for this age group are considered High Equity. If the plan s average equity exposure from ages 0-6 is between 60% and 90%, then it is considered Medium Equity, and a plan with less than 60% equity at this age interval exposure is considered Low Equity. While this new peer group methodology is an important tool in comparing performance of different age-based portfolios, it can also be used to evaluate the risk profile of an entire glide path. College tuition inflation has outpaced regular inflation by about 3% per year for the last decade, with no signs of abatement. Thus, a more aggressive approach in the earlier accumulation years may be necessary to combat this higher inflation rate. As a result, the Tomorrow s Scholar age-based portfolios maintain a higher allocation to stocks, for longer, than do most age-based 529 portfolios. Below is a graph of the Tomorrow s Scholar 529 plan s age-based equity allocation versus the Industry Average, according to data compiled by Morningstar. 4
A steep glide to fixed income takes place to mitigate a shortfall directly before and during enrollment. For example, the age 18 portfolio has a 10% allocation to equities, while the industry average is a 14% equity allocation. To mitigate principal risk, the age transitions of the portfolios closer to enrollment occur in one-year increments (age 15, age 16, age 17, etc.), as opposed to three-year increments in the earlier portfolios, allowing for a faster, smoother glide down from equities to fixed income. Seeking a competitive edge: Tomorrow s Scholar glide path vs. Morningstar 529 Peer Groups 100 Equity > avg. 80 High Peer Group 60 Medium Peer Group 40 20 Low Peer Group Equity < avg. 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 College Saver Age 2016 Tomorrow s Scholar Equity Allocation Source: Morningstar, Voya Investment Management Voya s MASS team stress-tests the age-based portfolio suite, running randomized simulations to estimate a range of performance outcomes versus college inflation. The tests combine Voya s long-term capital market forecasts with the outputs of TIAA-CREF s college tuition inflation model. Such testing is central to the MASS team s confidence in its glide path design. 5
Managing volatility: asset class diversification In addition to managing the overall portfolio allocation to stocks and bonds, Voya believes diversification within each allocation is also important. The Tomorrow s Scholar age-based portfolios combine the broad diversification of 14 asset classes, each of which features automatic reallocation as a client s account transitions to the next age level. The asset allocation of the Tomorrow s Scholar 529 plan starts with the MASS team s long-term capital market forecasts. These forecasts provide estimates of expected returns, volatilities and correlations for major U.S. and global asset classes over a ten-year horizon. Historical data and quantitative model outputs are combined to derive evidence-based, forward-looking estimates. Based on these annually updated forecasts, as well as a more qualitative assessment of participant needs, the team sets the asset allocation. Diversification does not guarantee against a loss and there is no guarantee that a diversified portfolio will outperform a non-diversified portfolio. Voya Multi-Asset Strategies and Solutions (MASS) Team The MASS team of over 25 investment professionals manages more than $27 billion in outcome-oriented strategies for pension, defined contribution and individual investors; this figure includes over $11 billion in target-date and age-based assets. 1 Voya s MASS team believes college savings strategies should reflect the behavior and risk tolerance of the average participant, and should be consistent with capital market realities. We believe early-stage savers benefit from high equity allocations to maximize wealth accumulation and capitalize on long recovery times if market declines occur. The average saver s risk aversion rises dramatically as college enrollment approaches, when accumulated wealth is the greatest. This calls for risk management that minimizes the probability of large losses near enrollment. 1 As of December 31, 2016 6
Equity diversification Generally speaking, the purpose of stocks in a savings plan is wealth accumulation. Voya s MASS team seeks to optimize the wealth-building potential of the Tomorrow s Scholar plan by investing in a broadly diversified range of equity asset classes. The portfolios contain aboveaverage exposure to small- and mid-cap stocks in the early years, at a time when it is acceptable to take greater volatility risk. In later years, the exposures to small-cap and mid-cap stocks diminish rapidly. Exposure to small-cap stocks ceases with the age 13-14 portfolio; exposure to midcap stocks ends with the age 16 portfolio. To gain access to opportunities around the world, the portfolios invest in a diverse range of global equity asset classes, including U.S. large-cap core, U.S. large-cap growth, U.S. large-cap value, U.S. mid-cap growth, U.S. mid-cap value, U.S. small-cap, U.S. real estate, international developed markets and emerging markets. In addition, the portfolios with a longer time horizon invest in commodities to provide diversification and act as an inflation hedge.... connecting to the future Fixed income diversification Prudent asset allocation is needed within fixed income to mitigate losses at the crucial time period immediately before college enrollment. Having access to different fixed income sectors gives our team added flexibility. The Tomorrow s Scholar 529 plan has access to five fixed income sub-asset classes; core fixed income, short-term bonds, high yield corporate bonds, senior bank loans and Treasury inflation-protected securities. By increasing the portfolio s exposure to asset classes such as senior debt and short-term bonds, Voya seeks to reduce its sensitivity to interest-rate risk, which can profoundly influence the return of fixed income securities. Short-term bonds act as a diversifier within the more conservative portfolios, while still offering a yield over cash. Senior bank loans feature a variable interest rate that resets periodically, leading to potentially favorable performance when short-term rates rise. What s more, senior bank loans generally provides an interest premium to compensate for its higher credit risk. This preference for more credit sensitive assets is consistent with our position in high yield bonds, another asset class that acts as a diversifier within fixed income. 7
Manager selection An open-architecture 529 plan, one that hires external managers to manage part of the plan s assets, allows for stronger diversification among the sources of portfolio returns and helps reduce overall portfolio risk. Access to managers at different firms allows for a 529 plan to better diversify factor exposures. In addition, an open architecture can address certain fiduciary concerns that financial advisors may have, particularly that the plan manager is choosing funds for its own benefit. Generally, from 17% to 33% of Tomorrow s Scholar assets are externally managed, depending on the age-based portfolio. The plan employs a platform of world-class managers such as: 8
Benefits of open architecture Broad diversification by asset class, regions, styles and managers Flexibility that allows for maximizing each manager s expertise Helps reduce single-manager risk through diversified investment processes Allows us to choose the managers that we believe have the best chance to outperform the benchmark Provides flexibility when adding new asset classes and overcoming capacity issues Active fund selection and monitoring within each asset class provides additional return potential over time and eliminates single manager risk. The portfolios strategically combine proprietary and sub-advised third-party managed funds by evaluating the risk/return characteristics, relative performance, volatility and cross-correlation of the broad universe of underlying funds to construct optimal portfolios. Risk management and monitoring Once the parameters have been defined for the plan s glide path, asset allocation and choice of funds, they are implemented by a dedicated team that specializes in fund-of-funds construction and management. Rebalancing guidelines are set up for each strategy to better assess transaction costs and risk parameters Daily monitoring report compares security weights to target allocations and flags discrepancies that breach a certain level Proprietary software platform used to manage and monitor all funds of funds Designed to increase scalability and implementation efficiencies Investment and operational risk overseen by independent team 9
Flexible investment options for different needs Tomorrow s Scholar offers three distinct ways to invest: by age, by risk level and by custom-building portfolios for clients. Advisors can tailor a portfolio for each client s particular situation with investments that feature some of the largest and most respected asset management firms. As an alternative, investors with a risk tolerance that differs from the equity allocation suggested by the glide path can elect for one of the risk-based portfolio options. For example, if a beneficiary is seven years old, but the account owner is not comfortable with an 85% allocation to equities, the account owner has the option of investing in the plan s Conservative Plus portfolio, which has only 65% allocated to equities. Range of investment options creates flexibility for client needs Aggressive Growth Growth Plus Balanced Conservative Plus Ultra Conservative Equity 95% 85% 65% 45% 10% Fixed Income 5% 15% 35% 55% 90% Large Cap Mid Cap Small Cap International Commodities Real Estate Intermediate Term Bond High Yield Bond Senior Loan TIPS Short Term Bond Savers also have the option to create their own portfolios, choosing from a variety of Voya managed and sub-advised funds across asset classes, including: Large Cap Columbia Dividend Opportunity Voya Corporate Leaders 100 Voya Large Cap Growth Voya Large Cap Value Mid Cap Voya MidCap Opportunities Voya Multi-Manager Mid Cap Value Option Small Cap Northern Small Cap Value Voya SmallCap Opportunities Global/International Voya Multi-Manager Int l Equity Fixed Income Columbia Limited Duration Voya GNMA Income Voya High Yield Bond Voya Intermediate Bond Asset Allocation/Balanced BlackRock Global Allocation Voya Global Perspectives Real Estate VY Clarion Global Real Estate Principal Protection TIAA-CREF Principal Protection 10
Conclusion: Tomorrow s Scholar competitive advantages The underlying investment process of a 529 plan that you choose potentially plays a significant role in providing the savings that clients accumulate for college, and thereby can impact the education that clients can afford for their children. The Tomorrow s Scholar 529 age-based portfolios can help parents reach this financial goal through its disciplined approach to managing the factors that drive return: Transition from wealth building to wealth preservation: Voya believes the best approach to glide path design is to maximize wealth accumulation at the early stages and have an accelerated reduction of equity as college enrollment nears, to limit the potential for significant losses. Mix of asset classes: Voya invests in a broad range of asset classes to provide broad diversification, global market exposure and access to alpha opportunities across capitalizations, styles and regions. Mix of fund managers: Voya is one of only a few 529 plan managers to offer nonproprietary managers among its choices for savers. Voya believes this is consistent with prevailing best practices in the management of defined benefit and defined contribution retirement plans. Risk management: Proprietary analytics help us evaluate managers for inclusion in portfolios, evaluate manager contributions to results, manage portfolio risks, reduce the potential for detrimental surprises and manage portfolio tracking error. 11
You can help your employees reach their higher education funding goals. For additional information on Tomorrow s Scholar, visit TomorrowsScholar.com or contact your financial advisor. Tomorrow s Scholar is a state-sponsored 529 plan administered by the State of Wisconsin. Voya Investments Distributor, LLC, a Delaware limited liability company provides investment management, administrative and distribution services for the Tomorrow s Scholar Plan. An investor s or a designated beneficiary s home state may offer state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in that state s qualified tuition program. Please consider this before investing Earnings component of non-qualified withdrawals may be subject to federal and state taxes and the additional federal 10% tax. The tax information herein is not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding tax penalties. Taxpayers should seek advice based on their own particular circumstances from an independent tax advisor. Investments in Tomorrow s Scholar 529 Plan are subject to certain charges, which will reduce the value of your Account as they are incurred. Please see the Program Description for details of charges or fees that apply to the specific Tomorrow Scholar savings plan. Investments in Tomorrow s Scholar 529 Plan are subject to investment risks, including the loss of the principal amount invested, and may not be appropriate for all investors. Voya Investment Management is not an underwriter for any underlying municipal securities. An investor should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. More information about municipal fund securities is available in the issuer s Program Description. You may obtain a Program Description at TomorrowsScholar.com or by calling 866-677-6933. The Program Description should be read carefully before investing. Voya Investment Management Co. LLC, provides investment management and administrative services for the Tomorrow s Scholar 529 Plan. Shares in the program are distributed by Voya Investments Distributor, LLC, Member FINRA/SIPC, a wholly owned subsidiary of Voya U.S. 2017 Voya Investments Distributor, LLC 230 Park Ave, New York, NY 10169 All rights reserved. W529-AGEBASED 111617 IM0504-34134-0518 170392 Not FDIC Insured May Lose Value No Bank Guarantee