Hedge Fund Managers with performance-based fees are likely to take on more risk when they have discretionary authority over investments in a favorable market environment, because they are more concerned with fee income than survival. This is an implicit cost to investors in the fund, because more risk is taken without additional return. To combat this problem, investors can require managers to have a sizable stake in the fund or incorporate a claw-back provision in the fee calculation.
CAI, L., CHENG, J., MARAT, M.
(2017). Moral Hazard Problem in Hedge Funds: A Study of Commodity Trading Advisors (CTAs). Journal Of Portfolio Management, 43(2), 77-89.
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