Unusually the decision has been taken not on ethical grounds but in response to the perceived investment risk of the shares.
With a portfolio of $74.5bn (pounds 48bn), the New York pension fund is the second-largest in the US after California's. It has $636m invested in Philip Morris, American Brands and other tobacco companies.
Part of the state's tobacco investment is in BAT shares, which although they closed 1p higher yesterday at 488p, have tumbled 15 per cent since the beginning of March, wiping pounds 2.6bn from the tobacco and insurance group's market value.
The decision, announced by New York's comptroller, Carl McCall, came on the heels of a week of misery for most tobacco companies, which have seen a near-vertical plunge in their share prices. Philip Morris and RJR Nabisco have slumped 16 per cent and 15 per cent respectively.
The turmoil follows the decision last week by the Liggett Group to settle in a high-profile class-action suit against tobacco manufacturers, claiming that they deliberately manipulated nicotine levels in cigarettes to turn smokers into addicts.
Attention is focused now on whether the slide in tobacco stocks is a short-term blip caused by a storm that will pass, or whether investors will reassess the risk of buying the stocks and spurn them over the long term.
"I think there has been a fundamental shift because a whole lot of new information is coming to light about what the companies knew in the past about the addictiveness of nicotine," Graham Kelder, a lawyer with the Tobacco Products Liability Project at Northeastern University said yesterday. "This is looking bad for the industry, because it really looks as if you have got people who are willing to kill other people to make money".
Fund managers in London were yesterday taking a more sanguine view of tobacco stocks. One leading manager, who asked not to be named, said: "There are risks but you have to weigh up the price you are paying for that risk. To say never is a little dramatic."Reuse content