Answer: Ensure that the hedge fund managers have a sizable amount of their own wealth invested in their fund.

## Explanation **Correct Answer: C** - Ensure that the hedge fund managers have a sizable amount of their own wealth invested in their fund. ### Why This is Correct: The question addresses **asymmetry in risk sharing**, which refers to the principal-agent problem where hedge fund managers may take excessive risks because they share in the upside (through performance fees) but don't fully bear the downside losses. This creates an incentive misalignment. **Option C directly addresses this asymmetry** by ensuring managers have "skin in the game" - when managers invest their own wealth in the fund, their interests become better aligned with investors. They share both the upside AND downside, reducing the incentive to take excessive risks. ### Analysis of Other Options: - **Option A**: Diversification across strategies doesn't solve the fundamental asymmetry problem - it just spreads the risk across multiple asymmetric relationships. - **Option B**: Reputation alone doesn't guarantee alignment of interests - even reputable managers can have misaligned incentives. - **Option D**: Daily monitoring provides transparency but doesn't change the fundamental incentive structure that creates the asymmetry. ### Key Concept: The **principal-agent problem** in hedge funds creates asymmetric risk sharing where managers benefit from upside but don't fully bear downside risk. Requiring managers to invest their own capital ("skin in the game") is the most direct way to align incentives and mitigate this asymmetry.

Author: LeetQuiz .