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Q

I own a D.C. tobacco bonds in my account at FMS. Despite your optimistic view, I have noted its continual decline in value this year to a current 63.624. Why is that?

A

James A. Klotz responds:

This year has seen a major market dislocation as large institutions and mutual funds have been forced to sell bonds at depressed prices to meet redemption demands. As a result, bond prices have fallen to levels far below the intrinsic value of the actual instruments. The vast majority of bonds continue to pay principal and interest in a timely manner as they always have. This goes for tobacco settlement bonds as well. We see market prices as undervaluing the steady cash returns that tax exempt municipal bonds have provided for many years.

In the specific case of tobacco bonds, the same forces battering the rest of the market apply here as well. So, despite victories in the courtroom, the tobacco sector has seen values fall, reflecting overall market conditions.

A recently enacted increase in the Federal excise tax on cigarettes from 39 cents to $1.01 per pack has also had an adverse impact on the market values of tobacco bonds, since its effect on cigarette shipments is uncertain. In the past, when states have raised their excise taxes, there is initially a shipment decline, which has been followed by a rebound to more traditional shipment levels.

Tobacco bonds have provided steady returns to their owners and the tobacco companies remain highly profitable.

As always, we will continue to monitor this sector.