The four states that cut $40 billion worth of separate deals with cigarette companies have started investing their first payments.
Many other states, however, don't know how they'll invest -- and spend -- the bumper crop of tobacco-litigation proceeds they'll begin to see Dec. 14, as the first checks from a $206 billion, 25-year master settlement agreement are paid out.
Of the four states not in the master agreement:
* Mississippi has picked 14 fixed-income, balanced, equity, convertible bonds and covered call managers to invest more than $285 million.
* Texas has invested assets parallel to its university endowment -- except it has excluded tobacco-related securities; some 50% of assets are indexed.
* Florida, starting with a domestic investment program, plans to move into international and probably real estate shortly.
* Minnesota is managing the assets in a laddered fixed-income strategy.
Among the states included in the agreement, some won't begin to address investment issues for a year or longer.
For example, decisions on asset allocation for Kansas' slice of the pie -- to be invested by the Kansas Public Employees' Retirement System -- won't be made until next year, said Robert Woodard, the system's chief investment officer.
Kansas' tobacco settlement money will be used to fund its new Kansas Endowment for Youth Fund, which in turn will fund a host of child-related programs.
This year, $20 million had been advanced from the state's general operating budget to finance the program; the fund's first $20 million tobacco payment thus will be used to repay the state.
So Kansas officials have until next year, when a $53.5 million payment is due, to determine the investment parameters.
In many cases, the bulk of the assets are being handed over to a wide array of existing and newly created endowments and foundations. In others, however, proceeds will be spent in the current year with little or no assets held for the long term.
80/80 test met
The Nov. 12 resolution of the last tobacco claim in Virginia means the 46 states, the District of Columbia, and five commonwealths and territories have achieved the magic "80/80" test under the landmark settlement reached a year ago.
Under that test, 80% of states in the suit accounting for at least 80% of the proceeds have signed off on the agreement and settled outstanding claims.
That will enable the first payments from the $206 billion master settlement agreement to go into state coffers. A second payment will be made in January.
Up-front payments totaling $12.7 billion will be made over the first five years, while payments totaling $183.2 billion will be paid annually over the next 25 years, starting April 15.
Some state and local officials are antsy to get their money up front, and are contemplating securitizing their payment stream.
Not only would governments be able to spend or invest the assets right away, but risk of the tobacco companies going bankrupt from continued litigation and declining tobacco consumption would be transferred to investors.
New York City's recent $709 million issue of Tobacco Flexible Amortization Bonds was the first such issue; the city plans three more of equal size. The city will use the $2.8 billion in proceeds -- representing 43% of the $6.7 billion it is due under the settlement -- to pay for schools and other capital projects. (New York State retains 51% of its $25 billion in total tobacco payments, with New York City and other localities divvying up the balance.)
New York City's success might encourage other states to securitize their settlement payments.
However, all securitizations are not equal. New York State Comptroller H. Carl McCall has blasted Nassau County for planning to use proceeds of its November securitization to cover its budget deficit.
"Once again, Nassau County is the poster child for how not to manage a budget," said Mr. McCall, a Democrat. Republican County Executive Thomas Gulotta did not respond to a request for comment.
Some states know how they'll spend the money, but not how they will invest it.
Michigan, for example, has allocated some $200 million a year to education, health and special projects, which will be spent on an ongoing basis, said John Truscott, press secretary to Gov. John Engler. After the initial $104 million payment, Michigan's payments range from $279 million to $325 billion.
A special trust fund providing scholarships for Michigan high school students will be backed by an endowment fund that most likely will be run by the Department of Treasury, but the fund will be relatively small.
The most detailed investment information comes from the four states not in the master settlement agreement. Here's what's been done so far.
The newly established Mississippi Health Care Trust Fund, Jackson, has $300 million in assets, with another $221 million due in December and early January.
Last year, fund officials picked five bond managers to run $125 million, with three balanced managers picked this spring to manage $100 million.
For bonds, the fund picked four short-term duration managers: Neuberger Berman Inc., New York, to run $45 million; Trustmark National Bank, Jackson, $20 million; and Smith Shellnut Wilson LLC, Jackson, and NCM Capital Management Group Inc., Durham, N.C., $10 million each. Investek Capital Management, Jackson, was hired to run a $40 million intermediate-term portfolio.
The balanced managers are: INVESCO Inc., Atlanta, $55 million; Hilliard Lyons Investment Management Group, Louisville, Ky., $10 million; and Vector Money Management, Jackson, $35 million.
Earlier this fall, fund officials hired Eaton Vance Management, Boston, to manage $20 million for covered call options; and Froley, Revy Investment Co., Los Angeles, to run a $45 million convertible bond portfolio.
In addition, four large-cap domestic equity managers have just been picked although allocations have not yet been set: J.P. Morgan Investment Management Inc., New York, for an enhanced index fund; Scudder Kemper Investments, New York, for contrarian value; Legg Mason Capital Management, Baltimore, for relative value; and Alliance Capital Management, New York, for growth.
Those portfolios will be funded out of new cash flows.
Next spring, the fund will launch searches for international equities, small-cap growth and midcap equity mandates, using the next $221 million payment due in a year's time, said State Treasurer Marshall Bennett, who chairs the fund.
Logan Partners, Jackson, is serving as the consultant.
Mr. Bennett said the fund will total $1 billion within three years, and will reach $3 billion by 2007, and somewhere between $6 billion and $7 billion by 2020.
Texas has allocated 83% of its funding to 21 endowment funds covering higher education, health-related institutions, nursing and minority health research and education.
Of the initial $1.49 billion payment, the University of Texas Investment Management Co., Austin, is managing $890 million in its new Permanent Health Fund for Higher Education, an internal mutual fund. The remaining $595 million has been allocated to 13 university health and medical endowments in Texas.
The UTIMCO pooled assets are being invested parallel to its $11 billion in other endowment funds, with the exception that assets are invested tobacco-free.
About half is being invested in passive tobacco-free funds, managed by Barclays Global Investors, San Francisco, that track the Standard & Poor's 500, S&P Midcap 400, Russell 2000 and Morgan Stanley Capital International Europe Australasia Far East indexes.
The Investor Responsibility Research Center, Washington, provides research to BGI on tobacco stocks.
The tobacco-free requirement makes little difference to stock portfolios, according to BGI officials who are launching a series of tobacco-free index funds.
For an S&P 500 fund, it means excluding three companies, accounting for 0.64% of the index's market cap, said Robert Ginis, managing director at BGI.
For an MSCI EAFE portfolio, tobacco-free investing means exclusion of seven stocks in seven countries, equal to 0.52%, Mr. Ginis said. For an MSCI Emerging Markets Free portfolio, 10 companies in 10 countries would be excluded, or 1.99% of the index, he said.
On behalf of the newly formed Lawton Chiles Endowment Fund, the Florida State Board of Administration, Tallahassee, will invest tobacco-litigation proceeds into international equities and probably real estate after it receives an expected $375 million payment in late December or early January. It has not been decided whether the new allocations will be managed internally or externally.
The $725 million received last June by the Lawton Chiles fund, which finances programs for youth and seniors, is invested 60% in domestic equities, 35% in domestic bonds and 5% in cash.
However, there's a good chance the domestic stock portfolio, now 100% invested in an internally managed index fund tracking the Wilshire 2500 (ex-tobacco stocks), will include some active strategies.
This state must deal with numerous investment restrictions imposed by the Legislature on the $1.3 billion it will pull in over five years.
Under legislation signed by Gov. Jesse Ventura, $968 million will be set aside in two health-related endowments: a $590 million fund for tobacco prevention and local public health; and a $378 million fund to finance medical education and research.
Managed by the Minnesota State Board of Investments, St. Paul, the funds will be entirely invested in laddered fixed-income securities over the life of the fund, according to board minutes.