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Tobacco-bonds rally earns 32% for year

– High-yield municipal bonds backed by payments from tobacco companies under a 1998 settlement have earned 32 percent tax-free this year, beating all classes of state and local debt, according to Barclays Plc data.

In 2013, the rally is poised to slow, and investors may have to settle for the income they get from clipping coupons, said analysts such as Bart Mosley, co-president of Trident Municipal Research in New York.

Even as some bondholders get a boost from a $1.7 billion settlement this month between states and cigarette makers over disputed payments, the trend toward falling consumption remains.

“Buying tobacco bonds at this point is a little bit of a game of musical chairs,” said Mosley, a former head of municipal arbitrage trading at UBS AG. “You don’t want to get sucked into the good story now, because you’re liable to be the guy left standing when the music stops.”

Speculative-grade tobacco bonds are ranked below Baa3 by Moody’s Investors Service and under BBB- by Standard & Poor’s. The securities, gaining for a second straight year, have benefited along with lower-rated assets across the fixed-income universe as Federal Reserve efforts to suppress borrowing costs pushed investors grasping for yield into riskier areas.

The $3.7 trillion muni market has returned 6.7 percent this year, while Treasuries have earned 1.9 percent, Barclays data show. Benchmark 20-year local-debt yields set a 47-year low of 3.27 percent Dec. 6, according to a Bond Buyer index.

The high-yield muni tobacco-bond market is about $33 billion, data compiled by Bloomberg show. The total market, which also includes higher-rated bonds with state guarantees, is $100.5 billion.

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