Lehman, AIG, Merrill: Which Funds Are Most Affected?

If you own a mutual fund, you're probably wondering how the latest financial sector developments affect your investments. In a separate article, my colleague Christine Benz discusses investor safeguards in place to protect you in some respects, but the stock market's reaction is a whole different ballgame. While the latest developments underscore the severity of the problems facing financials, there's also a lot of noise and fear in the market. We think sticking with a long-term financial plan and remaining patient amidst this storm is the best course of action (or nonaction). Even so, there are some funds that are more exposed than others, so we've tried to isolate funds most affected below.

Big Holders of Lehman Brothers
Stockholders of  Lehman Brothers are hurting the most. The stock, which traded as high as $62 within the last year, is now down to pennies on news that it has filed for bankruptcy. The table below shows which funds had the most concentrated exposure to Lehman as a percentage of their assets.

Big Lehman Holders
	Category	Portfolio Date	% Exposure
Fidelity Sel Brokerage & Inv	Financial	07-31-08	5.27
Morgan Stanley Fin Svs B	Financial	06-30-08	3.22
Legg Mason Partners Ag Gr A	Lg Growth	06-30-08	3.19
API Efficient Frontier Value C (YCVTX)	Mid-Blend	05-31-08	2.45
Ehrenkrantz Growth (EKNGX)	Lg Blend	03-31-08	2.34
ING Legg Mason Partners Ag Gr I	Lg Growth	06-30-08	2.29
Saratoga Large Cap Value I (SLCVX)	Lg Value	06-30-08	2.28
Oppenheimer Quest Balanced*	Mod Alloc	04-30-08	2.24
Osprey Conc Lg Cap Val Eq Instl	Lg Val	06-30-08	2.1
Pioneer Select Growth A (PSEFX)	Lg Growth	07-31-08	1.82
Data is as of the most publicly available portfolios. * Oppenheimer has told us that Quest Balanced's position in Lehman Brothers was 0.45% of assets at the end of August.

As the table above shows, the more meaningful damage was contained to funds that specialize in the financial sector.  Legg Mason Partners Aggressive Growth held the most significant position by a diversified fund. That fund, managed by Richard Freeman, owned 1.7% of the company's outstanding shares as of June 30, 2008.  The fund's stake dated back to 1995 and Freeman had been hanging onto Lehman, saying the company has gone through other hardships and managed them well. He also pointed to its strong franchises and investment banking business. We still like the fund and think Freeman is a talented investor, but Lehman will go down as a mistake for him. Even so, Freeman has had plenty of stock-picking wins over the years to give us confidence in his approach. Moreover, Lehman made up 3.2% of the fund's assets, so the impact will be limited to roughly that amount.

When we took a broader view to see which fund families as a whole have the most exposure to Lehman stock we found the impact on fund families to be pretty benign. Vanguard topped the list in terms of absolute dollars invested, but none of its funds individually had too large a bet.

American International Group
Behemoth insurer AIG reportedly intends to raise $40 billion, a move that could be highly dilutive to shareholders as that amount is greater than the company's market capitalization at the end of Friday. The end result for AIG and its stockholders is still highly uncertain, so it's unclear what the ultimate impact will be on funds that own it. The table below shows the funds with the most concentrated positions as a percent of their assets.

Big AIG Holders
	Category	Portfolio Date	% Exposure
Fidelity Select Insurance	Financial	07-31-08	16.7
Clipper	Lg Blend	06-30-08	6.05
Fidelity Growth & Income	Lg Blend	07-31-08	5.39
Grisanti Brown Value I	Lg Blend	03-31-08	5.32
Haverford Quality Growth Stock	Lg Blend	04-30-08	5.3
Diamond Hill Fin Long-Short A	Financial	07-31-08	4.89
Capital Advisors Gr	Lg Growth	03-31-08	4.31
Bristlecone (BVPFX)	Lg Value	05-31-08	4.26
Thompson Plumb Growth	Lg Blend	06-30-08	4.24
Fidelity Select Financial Services	Financial	07-31-08	4.07
Data is as of the most publicly available portfolios.

 Clipper Fund has a concentrated stake in AIG and has been paying for it with its returns. The fund has lost nearly 28% thus far in 2008, and that's before today's prices are reflected in its NAV. The advisor to Clipper, Davis Selected, has made AIG a sizeable bet across its other funds, too,  Selected American and  NY Venture . The stake is larger here because Clipper is intentionally more concentrated in management's best ideas. The managers told us earlier this summer that they had even been adding to ugly holdings, such as AIG, because they felt it was further along in purging its balance sheet of poor investments and still had considerable long-term earnings power. Unfortunately, the situation at AIG only continues to worsen beyond most investors' expectations.

 Fidelity Growth & Income has a large stake in AIG as well and it is proving to be another falling knife for the fund. Manager Tim Cohen had pointed to valuation as a key reason for owning AIG. Unfortunately, he had similar sentiments about  Fannie Mae and  Freddie Mac , which have also tanked.

Merrill Lynch
The Merrill Lynch takeover hasn't ended up looking so dire for investors in Merrill's stock. The proposed transaction, a $50 billion all-stock trade where each Merrill share will be exchanged for 0.8595 shares of Bank of America stock, looks like it will leave Merrill stockholders with a small premium. Bank of America's stock price closed at $33.74 on Friday and even though it had traded down into the $27 dollar range Monday, it still is worth more to Merrill shareholders than Merrill's $17.05 closing stock price on Friday. The biggest fund owners are listed below:

Big Merrill Lynch Holders
	Category	Portfolio Date	% Exposure
Natixis Harris Assoc Lg Cp Val A	Lg Blend	06-30-08	4.84
Morgan Stanley Fin Svs B	Financial	06-30-08	4.74
MassMutual Select Focused Val A	Lg Blend	05-31-08	4.62
Foresight Value	Mid-Val	03-31-08	4.55
JHT Fin Svs Trust Series III	Financial	07-31-08	4.45
JHT Fin Svs Trust Ser I	Financial	07-31-08	4.45
Clipper	Lg Blend	06-30-08	4.42
Davis Financial A	Financial	06-30-08	4.17
Natixis Harris Assoc Foc Val A	Lg Blend	06-30-08	4.03
MMA Praxis Core Stock B	Lg Blend	08-31-08	3.86
Data is as of the most publicly available portfolios.