Hedge funds

American International Group’s (AIG) stock has fallen 10% over the past three months. This was mainly due to weak operating performance, higher reserve developments, and declining returns on alternative investments. The company reported an operating loss in the fourth quarter of 2015 on a $3.6 billion reserve charge. AIG is targeting an exit from the hedge fund business in order to boost capital and redeploy that in credit.

AIG’s Valuation Declines: What Will Drive the Stock?

Lower interest rates and falling yields on alternative assets led to lower investment income in recent quarters. This trend is expected to continue for the upcoming quarter, given the current interest rate environment.

Valuation

Since insurers are balance-sheet-driven, they’re generally valued on the basis of their book values. AIG is trading at a one-year forward price-to-book multiple of 0.7x compared to its peers, which are trading at 1.2x.

At a current price-to-book multiple of around 0.8x, AIG is trading lower than other insurers, including Allstate (ALL), ACE (ACE), and Chubb (CB). On a one-year forward price-to-earnings basis, AIG is trading at 10.4x compared to the industry’s 11.6x earnings multiple for the same period. The company’s valuations have declined due to a weak insurance underwriting business, higher regulation costs, and lower alternative investment returns.

AIG’s shares appear to be valued at a discount, given the company’s strong brand and balance sheet. There’s an expectation of improved operating performance in the upcoming quarters, with recovery in the core business. Improved capital structure, reduced risk, and deployment of fresh capital in the expansion of the company’s core business are expected to boost its profitability in the long run.

Investors can gain exposure to insurance companies by investing in financial sector ETFs such as the Financial Select Sector SPDR ETF (XLF) and the iShares US Financials ETF (IYF).

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