Fund of funds (FoF) were created to serve as a bridge for LPs to get access to managers they couldn’t back otherwise. But in an environment where funds are not seeing consistent support from their existing LPs, and there are more venture funds than ever, is their role still relevant?
Fund of funds fundraising — say that five times fast! — has declined for years. To compare, traditional U.S. venture firm fundraising set a record in 2022 with $162 billion. U.S.-based VC FoF raised just $400 million in the first quarter of 2023, according to PitchBook, and $3 billion in 2022. This compares to $24.4 billion in 2021 and $33.7 billion — the fundraising peak — in 2017.
It’s not surprising why many LPs have soured on the strategy, said Kyle Stanford, a senior venture analyst at PitchBook. For one, backers of these funds pay a mix of fees to both the FoF and the underlying commitments the FoF manager makes.
“LPs have that double layer of fees. And that extra time it takes after [an LP] invests in the fund of funds and then have it deployed is just something that LPs right now just don’t want to deal with,” Stanford told TechCrunch+.
And with there being so many new firms and funds in the market, the issues surrounding LPs not getting access to attractive VC funds is largely moot and that barrier isn’t really an issue anymore, he said. “There has been way more opportunity to invest in a VC than there has ever been in the past,” he said. “For new LPs coming into the market, they didn’t need to go to a fund of funds to get access.”
But to be clear, even if the funding numbers are down, FoF still holds a place in the future of venture — maybe just a different one than they did traditionally. Multiple firms have started innovating on the model, and FoF can still help LPs get access to the managers they can’t invest in otherwise, albeit for different reasons than before.
One model is designing an FoF strategy that helps larger LPs invest into emerging managers, a group that research shows almost consistently outperforms bigger VC funds. But that comes with a different access issue: Some large LPs can’t cut checks small enough to get into an emerging fund without holding a larger stake of the fund than they’d like or might be allowed to.
Recast Capital is a newer FoF looking to fix that. Recast is raising $100 million so that larger LPs can back Recast and they can cut checks to diverse emerging managers. Recast’s website highlights not only that it can help LPs get into these smaller funds now but that doing so also helps LPs build a relationship with these firms, which could grow into the funds LPs fight to get into in the future.
Many funds are also adding FoF strategies within their existing funds, giving their LPs access to emerging managers in addition to the funds’ underlying portfolio companies, too.
For instance, Level Ventures announced its debut fund on Thursday. Its take on venture investing allows LPs access to the funds they think are the most likely to produce alpha based on an in-house data model. And that’s in addition to the companies these funds back that seem most likely to succeed.
Plus, Albert Azout, the firm’s co-founder and managing partner, told TechCrunch+ that it purposefully charges fewer fees than other FoFs in a quest to make it a more attractive option for LPs. For example, family offices that want to do more in venture but have maybe been turned off from the FoF fee structure.
“We had some innovation around the fee structure, not so much innovation as far as really reduced fees for a fund of funds index,” Azout said. “We really had some product market fit. In the market you have individuals, high net worth individuals, and family offices that all are undervalued to venture.”
Other funds have started to add this as a specified sleeve of their strategy, too, including Plexo Capital, Reshape Capital and Atento Capital.
But even without a distinct FoF capital pool, an increasing number of venture funds are starting to incorporate LP investing into their plans to begin with, including Andreessen Horowitz and Lightspeed. This means that their LPs have the opportunity to back who they have a long-standing relationship with, as well as get commitments to a few emerging managers that they maybe wouldn’t have been able to access due to size constraints.
So, no, this isn’t the end of FoFs but rather the ideal time for that sector to start innovating on the model. Because the appetite for backing someone else to vet the funds for you is clearly there, investors are just no longer interested in the status quo.