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Answer: Ensure that the hedge fund managers have a sizable amount of their own wealth invested in their fund.
The correct answer is C. Ensuring that the hedge fund managers have a sizable amount of their own wealth invested in their fund is the most prudent approach to mitigating the risk sharing asymmetry between the hedge fund manager and the investor. This asymmetry occurs when the hedge fund manager enjoys the benefits of upside risk but only partially suffers from the consequences of downside risk, while the investor is exposed to both. By having a significant personal investment in the fund, the hedge fund manager is more likely to be conservative in their risk-taking and consider both upside and downside risk, aligning their interests with those of the investors. Option A, diversifying across several hedge fund strategies, and option D, requiring daily position reports, may reduce overall risk but do not address the risk sharing asymmetry. Option B, choosing a reputable hedge fund manager, does not solve the asymmetry issue and relying solely on reputation is not prudent given past hedge fund scandals.
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A pension fund manager is planning to diversify the fund's portfolio by including hedge fund investments. The manager is, however, concerned about the potential disproportionate distribution of risk that may result from this allocation. To mitigate this risk, what measures should the pension fund manager take?
A
Allocate the money across several different hedge fund strategies to diversify away the asymmetry in risk sharing.
B
Choose a reputable hedge fund manager that manages investments for other major pension funds.
C
Ensure that the hedge fund managers have a sizable amount of their own wealth invested in their fund.
D
Require the hedge fund to provide a daily position report to better monitor the potential asymmetry in risk sharing.