Introduction

A Fund of Funds (FoF) is an investment vehicle that allocates capital across multiple venture funds, providing investors with diversified exposure to startups while outsourcing fund selection and management.

Venture capital (VC) has evolved from a niche industry into a complex asset class with multiple sub-strategies, including seed-stage, early-stage, growth-stage, and multi-stage investments. The increasing influx of capital from family offices and institutional investors has further diversified the landscape. According to Deloitte, the number of family offices globally has grown from 6,130 in 2019 to 8,030 in 2024, with projections suggesting nearly 11,000 by 2030. Additionally, the total assets under management (AUM) by family offices are expected to grow from $5.5 trillion to $9.5 trillion in the same period.

As more family offices and institutional investors enter venture capital, they are faced with a critical decision: Should they build their own direct investment strategy or invest through a Fund of Funds (FoF)?

Despite its advantages, skepticism persists around venture capital funds of funds. Below, we debunk the most common misconceptions and explain why many limited partners (LPs) should reconsider their stance.

Misconception #1: The “Double Layer of Fees” Makes Funds of Funds Underperform

One of the most common criticisms of funds of funds is the concern over double fees—where an limited partners pays both the funds of funds manager and the underlying VC funds. In asset classes like hedge funds, where return dispersion is relatively narrow, these extra fees can erode excess returns. However, VC is fundamentally different due to its high return dispersion.

In venture capital, top-quartile funds significantly outperform the median, making access to the best managers more important than fee efficiency. According to PitchBook data from 2005-2019, funds of funds actually outperformed direct VC investments, even after accounting for the additional fees:

• Top quartile: FoFs outperformed direct VC in 8 of 15 vintages, averaging a 0.27x TVPI advantage.
• Median quartile: FoFs outperformed direct VC in 14 of 15 vintages, with a 0.68x TVPI edge.
• Bottom quartile: FoFs always outperformed direct VC, with an average 0.89x TVPI lead—demonstrating superior downside protection.

Misconception #2: Investing in a Fund of Funds Signals Weakness

Some LPs fear that using a FoF suggests an inability to execute a direct VC strategy. However, venture investing is a time-intensive, access-driven game. The best VC firms are highly selective, and LPs without established networks often struggle to gain entry into top-performing funds.

Rather than indicating incompetence, partnering with a specialized FoF demonstrates strategic self-awareness. Many LPs are generalists managing multiple asset classes, including public equities, private debt, and real estate. Expecting them to also build a world-class venture portfolio without the necessary resources is unrealistic.

Misconception #3: Institutional Policies Against Funds of Funds Are Justified

Many institutions maintain a blanket “We don’t do FoFs” policy, often inherited from past leadership without reassessment. These policies stem from historical biases rather than data-driven analysis. In reality, well-structured funds of funds provide superior diversification, access, and risk-adjusted returns, making them a logical choice for many LPs.

When pressed, LPs often cite fee concerns or reluctance to outsource investment decisions. However, few conduct a rigorous evaluation of the trade-offs, and many underestimate the effort required to execute a direct VC strategy effectively.

Misconception #4: Funds of Funds Take the “Fun” Out of Venture Capital

Venture investing is inherently exciting—startups are building rockets, AI systems, and medical breakthroughs. Some LPs prefer direct VC investing not just for financial returns but for the experience, networking, and prestige.

While FoFs may seem more detached, top-tier FoFs actively engage their LPs through:

• Exclusive events with top general partners (GPs) and founders.
• Direct co-investment opportunities alongside FoF investments.
• Bespoke networking and industry insights, keeping LPs connected to the venture ecosystem.

Additional Benefits of Funds of Funds

Beyond superior access and reduced downside risk, venture FoFs offer practical advantages, especially for smaller LPs:

1. Vintage Diversification

Venture returns are highly cyclical. However, most LPs struggle to maintain consistent annual deployment. Instead, they invest more during market peaks and pull back during downturns—despite knowing the ideal strategy is the opposite.

A FoF naturally provides vintage diversification, as capital is deployed across 4-5 years, reducing exposure to single-cycle risks.

2. Cost-Effectiveness

Building an in-house VC team is expensive. Hiring a dedicated venture specialist can cost $250,000+ per year, while a FoF provides an entire team of experts for a comparable management fee.

3. Time Efficiency

Constructing a diversified VC portfolio requires thousands of hours meeting with managers, conducting due diligence, and structuring investments. A single FoF commitment streamlines this process into one diligence cycle and one capital commitment.

4. Operational Efficiency

Managing multiple VC investments involves numerous capital calls, reports, and K-1 tax forms. A FoF simplifies this by consolidating capital flows and reporting, reducing administrative burdens.

Final Thoughts: Time to Rethink Funds of Funds

Venture capital is one of the most challenging asset classes to execute successfully. Without deep networks and substantial time investment, LPs risk adverse selection—allocating capital to subpar funds while missing top-performing managers.

Funds of funds provide a streamlined, cost-effective alternative that offers:

• Superior access to top-performing funds
• More consistent returns with reduced risk
• Operational and administrative simplicity
• Strategic diversification across multiple vintages

While skepticism persists, much of it is rooted in outdated assumptions rather than factual performance data. If LPs are serious about optimizing their venture capital strategy, it is time to reconsider the role of funds of funds in their portfolios.

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