Citi: Tobacco Sell-off Will End Soon; Buy High Beta Tobacco
Tobacco bonds may soon recover from a sell-off that was exacerbated by Bill Gross' departure from PIMCO, according to the Citigroup strategist who identified the trend in a report Monday.
Tobacco bond yields jumped after Gross announced that he was leaving PIMCO for a new post at Janus Capital Group Inc. on Friday. The yield on benchmark Buckeye Tobacco Settlement Financing Authority's 5.875s of 2047 climbed by 18 basis points to 7.87% by Tuesday's market close from Friday, according to Bloomberg data.
Foux, director of credit, derivatives and muni strategy at Citi, said in an interview Wednesday that Citi doesn't think the sell-off will last long, and that the increased yield makes the bonds more desirable.
"We think investors should see this weakening as opportunity to start adding exposure [to tobacco bonds], especially if yields keep increasing," he said.
Tobacco bonds' yields initially began edging higher early last week. A trader in California told The Bond Buyer that was because tobacco bonds are being increasing affected by events in the high-yield corporate bond market, and that last week corporate bond spreads "went out a lot".
A trader in the south said that tobacco's performance is correlated to high-yield corporate bonds because tobacco bonds are a structured finance instrument, and therefore differ from traditional municipal bonds.
Standard & Poor's High Yield Corporate Bond Index's total returns fell all five days last week dropping from a total of 111.14 on September 22 to 110.03 on Friday.
Tobacco bonds are particularly sensitive to the performance of high yield corporate funds, the trader on the west coast said.
The iShares iBoxx $ High Yield Corporate Bond Fund reported a one week return of negative 0.62%, while the SPDR Barclays Capital High yield Bond ETF shows a one week return of negative 0.79%.
Mesirow Financial provided The Bond Buyer with three examples of tobacco bonds that it said showed how the corporate sell-off impacted tobacco bonds, including the benchmark Buckeye Tobacco bond mentioned above.
The Golden State Tobacco Securitization Corp. California tobacco settlement revenue asset-backed 5.125s in 2047 were trading at a high of 7.286% on Sept. 19, before the sell-off last week. On Friday it was trading at a high yield of 7.44%.
The Golden State 5.75s on 2047 were trading at a high of 7.28% on September 19, according to EMMA. By Friday the high yield jumped to 7.48%.
The high yield of 7.68% the Buckeye Tobacco 5.875s in 2047 was trading on Sept. 19 increased to 7.75% on Friday, according to EMMA. The data for the benchmark Buckeye Tobacco Bond listed above and in the chart was taken from Bloomberg, which averages the yield the bond traded at each day.
"In the last week tobacco prices have fallen," Peter Bianchini, managing director of institutional sales and trading at Mesirow, said in an interview. "It started with the corporate high yield sell off [last week] and the muni market was following that. Then they continued to fall after the Bill Gross announcement."
Since Friday's announcement the Golden State 5.125s in 2047's high yield rose by 79 basis points to 8.23% on Tuesday from Friday. The Golden State 5.75s in 2047 high yield jumped by three basis points to 7.43% on Tuesday.
Foux said the corporate high yield market did have a sway over tobacco bonds, but tobacco bonds' yields were not increasing because of a sell-off.
"A lot of crossover tobacco holders actually sold [their tobacco muni] holdings- not completely but largely- in the first six months of the year," he said. "The sell-off in high yield should not have caused sell off in muni tobacco, but it often causes people to stop buying tobacco bonds. When people stop buying yields start moving higher."
Citigroup wrote in a report published on Monday that Gross's departure could inject volatility into tobacco bonds because the Bellwether fund Gross managed held about half a billion dollars' worth of tobacco Master Settlement Agreement bonds .
The trader in the south said tobacco may be selling off after Gross left because some investors believed PIMCO is selling the fund's tobacco holdings, or in anticipation of PIMCO selling the holdings.
"Tobacco bonds are not widely held, so when people are selling you have that need to find a new incremental buyer," he said. "You have to find that incremental high yield buyer, and there are just not that many out there. When PIMCO came in, it was the new buyer, and now you may have to find another new guy. There are only so many buyers who want a bond like tobacco."
Foux called the sell-off after Gross' exit an "overblown reaction".
"Tobacco is a portion of [the Bellwether fund's] overall holdings," he said. "Compared to other muni holdings tobacco one of the more attractive sectors. If you do any relative value analysis and realize you need to liquidate some assets, tobacco would probably be really low on the list because its relatively cheap compared to other muni asset classes. "
He said that Citi recommends investors should add exposure to high beta tobacco.
"The high beta bonds, they were effected more [by Gross leaving] and will outperform going forward," he said.