Funds of Funds: What you need to know as a gender-smart investor

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Despite the fact that record capital has been flowing into VC and private equity, with US startups raising $329.9 billion in venture investments in 2021, women fund managers — particularly first-time and racially diverse women fund managers — continue to be systemically underfunded.

In the gender-smart community, many of us are working to change this — so that women fund managers can build and create wealth, so that they can get their funds to first close, and so that more capital flows with a gender lens to entrepreneurs.

One solution to this problem that some investors have turned to is the fund of funds: private market vehicles that invest capital not in businesses (or in the case of some funds of funds, not solely into businesses) but instead into funds, as a way to capitalise on unique market opportunities, diversify the face of who manages and invests capital, and widen the base of access to capital.

Over the last few years especially, we’ve seen more and more gender and diversity funds of funds come to fore, including Capria Ventures, Emerging Markets Impact Investment Fund (EMIF) from DFAT, Equity Alliance, Fairview Foundations Emerging Managers Fund, First Close Partners, Graham & Walker, Illumen Capital, Impact Bridge, Include Ventures, Multitudes, Oryx Impact, and Screendoor.

For investors who want to support new and diverse fund managers and benefit from the financial potential of their funds, funds of funds offer a way to diversify your investments, back a range of strategies with a single investment, and mitigate the risks of backing a new fund manager.

Here’s what you need to know.

What are funds of funds?

Funds of funds bring together a group of investment vehicles under a single umbrella, allowing investors to invest in funds that otherwise may not be accessible to them due to investment ticket size or the burden of sourcing, due diligence and active management. They also may have an intention of helping emerging fund managers gain visibility and access to new capital by pooling their resources.

There is a lot of variety in how funds of funds operate: some invest capital only, while others, like Screendoor and Illumen Capital, also provide mentorship and technical assistance for the funds in their portfolios, or investor education for LPs. Some, like Include Ventures and Multitudes, invest in both funds and companies, and thus may not necessarily call themselves a fund of funds. Some, like First Close Partners, play a catalytic role, helping participating funds get to first close.

Most funds of funds have a manager who chooses the set of funds to invest in, serves as an intermediary between the fund managers and the LPs, and tracks each fund’s performance from both a financial — and, if it’s an impact fund of funds — an impact perspective.

It’s worth noting that there are funds of funds in other asset classes, such as hedge funds and real estate. In this article, however, I am only talking about private market funds of funds.

What are the benefits to investors?

Funds of funds can offer investors greater flexibility in how they deploy their capital. They can enable institutional investors to participate in funds that would otherwise be too small, by placing one cheque into one vehicle that gets them into a diversity of funds. For smaller investors, they can offer the ability to access funds where the buy-in might otherwise be too large, accessing multiple funds with the same size cheque that they might have written into one fund.

They also offer investors a way to diversify their portfolios, with the benefit of an experienced fund of funds manager who has done the research to pull together the best funds in their strategy. For the funds of funds that invest not only into funds but also into direct deals, there is further diversification, mitigating risk and increasing potential upside.

Investors in funds of funds also benefit from the financial and impact dividend of the expert support that some funds of funds provide to their GPs. Ilumen Capital, for example, invests in funds that have a gender and/or racial equity lens, doing a lot of work with individual fund managers to get them gender- and JEDI-smart.

Finally, investing in a fund of funds reduces paperwork complexity, as all administration is managed by the one fund of funds manager, rather than spread over all the individual funds.

What are the benefits to fund managers?

As journalist Alex Konrad noted in Forbes last year, funds of funds offer a solution to some of the problems faced by emerging and underrepresented fund managers, helping them to access larger institutional investors such as pension funds and university endowments whose minimum investments are often too large to invest in first-time funds, reduce perceptions of risk, and pool resources to increase their visibility, meet their fundraising goals, and close their funds faster.

Fund managers in funds of funds also benefit from being able to draw upon the collective expertise of the other fund managers in their portfolio — as well as, often, the sector or other technical expertise of the fund of funds manager. Often there are synergies between fund managers within the funds of funds that allow for co-investment into portfolio companies, sharing pipeline, or talent sourcing.

Finally, like investors, fund managers in funds of funds benefit from the reduced complexity of the relationships and administration they have to manage, minimising the number of investor relationships they have to manage.

What challenges do funds of funds face?

The biggest barrier that funds of funds face is their double fee structure, which can be a turn off for investors seeking to minimise management fees. But this ignores the benefits that investors gain out of investing in a fund of funds structure: including the ability to buy into a portfolio of funds handpicked by someone who is an expert in the field, a shared approach to impact management and measurement, and the expert support some fund of funds managers provide to participating firms. For people who invest in funds of funds, these benefits are worth paying for.

Amongst LPs who are used to working with large institutional investors especially, it’s not uncommon to ask fund managers — or the fund of funds manager — to lower their fees. But this is unfair for emerging managers, and it’s not the world that we as gender-smart investors are working to create. Emerging fund managers are often working for years for little pay and on narrow margins. Asking them to lower their fees pushes the burden onto the shoulders of the people who can afford to carry it the least.

This is one area in which philanthropic actors can be useful, using their capital to cover some of the costs of running these funds of funds, bring fees down, and unlock private capital in the same way that some philanthropists are already doing through blended finance vehicles.

If there is a fund of funds that is working on issues you care about and you want to bring more capital to it, this is a really creative way to think about using your philanthropic capital. This option isn’t limited to high-net worth individuals or family offices, either — corporates and financial institutions could consider using their philanthropic capital in this way as well.

How can you get involved?

Funds of funds aren’t for everyone. If you’re someone who likes to pick and choose your investments and be closely involved with the funds that you choose, this may not be the right vehicle for you. But if you want to give a boost to more emerging fund managers and benefit from their market insights and expertise, and get into some funds that might not have been on your radar, you should consider it.

Funds of funds can be a powerful market shifting tool, helping new funds get off the ground in a lower risk way, and helping to diversify the face of investment — something that all of us in the gender-smart field would like to see. And if you’re a purely commercial investor, funds of funds are a great way to seize market opportunity and diversify the risk of investing in private markets.

If you’re someone who manages a wealth platform, you should consider offering funds of funds to your clients as an option to diversify their investments. And if you’re a philanthropist, you should consider using some of your philanthropic capital to help new fund managers working on the issues you care about get backed, and shift the entrenched systems that currently keep new and underrepresented fund managers locked out.

One thing is for sure: funds of funds are a growing and important subset of funds in the gender-smart ecosystem that everyone should be paying attention to. Stay tuned for some exciting news later in 2022, about forthcoming funds of funds that are yet to be announced!

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suzanne biegel

suzanne biegel

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Catalyst at Large and Co-Founder, GenderSmart, investor, change maker, movement building leader. catalystatlarge.com, @zanne2, gendersmartinvesting.com