Why Muni Investors Shouldn’t Smoke Tobacco

Why Muni Investors Shouldn’t Smoke Tobacco

It’s not normal. When a fixed-income sector beats the S&P 500 over an extended period and by a meaningful amount, investors do a double take.


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Tobacco bonds, which represent nearly one quarter of the muni high-yield market, have outperformed stocks by 3% annualized over the past three years. That’s been largely because of demand for a liquid sector in a market where supply has been particularly limited. It’s been a wild ride. But wild rides are often bumpy, and this one has been no exception.

The annualized volatility of the tobacco bond sector, as measured by standard deviation, was almost as high over the last three years as the equity market itself, and nearly twice as high as the rest of the high-yield muni market.

What is generating this kind of whipsawing volatility? Tobacco bonds’ payments are based on cigarette consumption. That means that anything affecting cigarette shipments—for better or for worse—affects the pricing of tobacco bonds. Federal proposals to reduce nicotine in cigarettes. More state or federal tobacco tax hikes on the table. Suggestions to add graphic photos on packaging. Regulations on indoor smoking. Growth of the e