HMS Otranto was carrying US soldiers and British crewmen when it sank off the coast of the Hebridean island in 1918 following a collision with another vessel.
Around 300 islanders and descendants of those who lost their lives gathered at the Commonwealth War Graves Commission cemetery at Kilchoman on Saturday.
Islay Lifeboat crew members also laid a wreath near the Otranto wreck site at Machir Bay.
Former defence secretary and Nato general-secretary Lord Robertson was among those who paid tribute to those killed.
His grandfather was a police sergeant on Islay in 1918.
He said: “My maternal grandfather, Malcolm MacNeill, had the distressing job of reporting what had happened and attempting to identify the bodies, noting any distinguishing marks that could help identify the drowned men.
“There were so many bodies that their descriptions filled 81 pages in his notebook.
“When they were finally buried, it fell to my grandfather to correspond with the families in the United States who were desperate to know more about the fate of their loved ones.
“They wrote with information which they hoped could be used to identify the bodies of their sons, husbands or brothers, and in an extraordinary example of compassionate public service, my grandfather replied to each letter, providing what information he could.”
The tragedy came just eight months after the SS Tuscania was torpedoed near the island, with around 200 men perishing.
Jenni Minto, chair of WW100 Islay, said “One hundred years ago the people of Islay were faced with the horrors of war arriving on their shores for the second time that year.
“Again they worked with compassion and humanity to ensure those who survived the Otranto tragedy were cared for as though they were their own, and those who sadly died were buried with dignity and respect.
“Today we paid tribute to those selfless acts and remember those who were lost.”