Understanding Fund of Funds: A Primer on Investing in Venture Capital

First Cheque

Episode Summary:

In this insightful conversation, co-hosts Cheryl Mack and Maxine Minter unpack the often misunderstood world of 'fund of funds'—investment vehicles that pool capital to invest in a variety of venture funds rather than in startups directly. Tailored for early-stage investors and industry observers, this talk reveals the nuances of fund structures and investment strategies designed to mitigate risk and maximize returns.

Diving into a no-nonsense explanation, Maxine elucidates the two foundational structures of venture funds—management companies and the standalone investing funds—and how funds of funds play into this ecosystem by investing in multiple funds. This episode shines a spotlight on the intricacies of fund growth, managerial sophistication, and the dynamic relationship between funds, funds of funds, and their limited partners (LPs). Cheryl probes into the motivations behind why LPs choose to invest in fund of funds, including access to top-tier funds and diversification that extends across emerging ventures.

Key Takeaways:

• A 'fund of funds' is an investment strategy where the fund invests in other venture capital funds rather than directly in companies.
• Most venture funds fail to return capital; however, emerging managers often are part of the top-performing funds, despite potential difficulty in scaling from one fund to the next.
• Institutions like pension and super funds, which frequently invest in funds of funds, face unique challenges such as VP clauses and monthly asset pricing pressures.
• Funds of funds can offer investors a lower-risk profile and a more diversified exposure to the venture capital market.
• There is a potential growth opportunity for fund-of-funds in Australia, which is currently a nascent market in this space.

Notable Quotes:

• "If you invest alongside, say, CoVentures, and CoVentures has a fund of fund that's invested in them, what does that mean for the potential success of the company later on down the road?" - Cheryl Mack
• "Venture funds being an indexation of the underlying assets... Our success is driven by, you know, an outlier in our portfolio." - Maxine Minter
• "Emerging managers consistently are in the top ten performing funds of every single vintage." - Maxine Minter
• "The venture funds themselves, their returns perform on a power law curve. So there's only a handful of funds, venture funds, that will deliver outlier returns to their investors." - Maxine Minter

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June 2024 – Vanta First Cheque

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