The Impact of AIG on Your Index Funds

September 16, 2008

By Ron DeLegge, Editor

SAN DIEGO (ETFguide.com) – How will troubled insurance giant American International Group’s (NYSE: AIG) crippling fall affect your investments?

If you’re fortunate enough to own a broadly diversified index mutual fund or exchange-traded fund (ETF), you’ve been largely shielded from the systematic risks associated with owning individual stocks. That's the good news. Conversely, investors that decided to concentrate their stock holdings should be rightly alarmed.  

Over the past year, AIG has seen its market capitalization melt from $175 billion to around $10 billion. And if AIG's stock price continues on its same destructive path, that $10 billion market value could end up becoming zero.

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As one of the 500 companies within the S&P 500 index (AMEX: SPY), AIG’s influence upon the index has been declining too. Why is that? Because as a market capitalization based index, the S&P’s movement and performance is most impacted by stocks with the largest market size. Since AIG no longer commands the huge market cap it once had, its affect on the S&P 500’s performance has substantially declined.

The same can be said of AIG’s market representation in the Dow Jones Industrial Average.

As a price-weighted barometer of 30 leading U.S. companies, the Dow’s movement (AMEX: DIA) and performance is most impacted by companies with the highest stock price. As today’s 1.3 percent gain in the Dow Industrials showed, it’s fair to say that AIG’s ailing stock price isn’t having the same impact as before. Put another way, AIG’s influence has greatly diminished.

This takes us to a common, but misplaced knock against index funds and ETFs.

Who’s done a better job of shielding investors from the financial pain of a bear market? Was it Wall Street’s fund managers that loaded up on AIG stock thinking it was a bargain? Or was it market index funds and index ETFs that by design have reduced their impact exposure to AIG? And what about other near bankrupt stocks that have seen their market values whither to almost nothing?

While the diversification of an index fund doesn’t protect you from losses, it can protect you from unrecoverable catastrophic losses. The same can be hardly said of mutual funds and hedge funds that have recently blown up.

Those who accuse index funds and index ETFs of not protecting shareholders better re-consider their flawed thinking.

In the meantime, index investors can rest assured that a few rotten apples like AIG, Bear Stearns, Lehman Brothers Holdings (NYSE: LEH), and the others that will no doubt follow – won’t completely blow up their portfolio.

In these troublesome times, getting a good night’s rest is just as important as reaching your financial goals.