U.S. Tobacco Bonds Outperform Municipal Indexes

U.S. Tobacco Bonds Outperform Municipal Indexes

Despite falling cigarette sales, U.S. tobacco bonds have performed better than the average municipal bond index, according to the Wall Street Journal.

The tobacco bond index maintained by S&P Dow Jones Indices had a 10-year total return of 134% through mid-December, while the general municipal bond index returned just 34%. From late October to mid-December, the tobacco index rose 13% as overall bond yields fell.

In 1998, the largest U.S. tobacco companies agreed to pay 52 U.S. states and territories $206 billion over 25 years in exchange for those jurisdictions dropping future legal claims related to the cost of treating sick smokers.

Rather than waiting for the money to trickle in, at least 21 states or territories, plus local entities in some of them, took the money upfront and transferred the risk to municipal bond investors.

In the year since the Master Settlement Agreement, tobacco bond owners have had to contend with the rise of non-combustible products such as e-cigarettes, which do not count against cash received.

The U.S. government has also threatened to ban menthol cigarettes, which account for about a third of domestic cigarette sales. The consumption tax also dampens demand. Since 1997, the consumer price index for tobacco products has increased by 530%, while the overall consumer price index has increased by 93%.

Tobacco companies, on the other hand, agreed to adjust for annual inflation to at least 3%. For years, that amount was more than states would have received if indexed for real inflation.

A recent surge in inflation has resulted in payments increasing by approximately 20% from 2019 to 2020.

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