Funds of funds (FoF) are increasingly used to shape how governments practice economic statecraft. When designed well, they pool capital to invest in venture funds rather than directly in individual companies or securities, strengthening innovation ecosystems while steering investment toward strategically important markets, capabilities, and technologies. But when poorly designed—as they often have been—these structures reproduce the all-too-familiar failures of politically captured investment programs.
Over the past three decades, public FoFs have been used primarily as instruments intended to attract private investors into early-stage venture capital markets, particularly in countries with limited domestic capacity. The best-known example is Israel’s Yozma programme, launched in 1993, but similar approaches were later adopted by Australia’s Innovation Investment Fund, the European Investment Fund, and the Saudi Venture Capital Company (SVC). Each used the FoF model to expand the supply of risk capital.
That era is now coming to an end, as governments increasingly use FoFs to direct capital toward critical national capabilities and strategic (often dual-use) technologies, screen out hostile or high-risk investors, and build innovation capacity at home and in allied countries. The United Kingdom’s National Security Strategic Investment Fund and Denmark’s 55 North quantum fund are prime examples. At the multilateral level, the European Investment Fund’s European Tech Champions Initiative and the NATO Innovation Fund (backed by 24 members) both reflect this shift.
As a result, the question is no longer whether governments should use FoFs to advance economic statecraft, but how to design them so that national-security priorities do not erode market discipline, and commercial logic does not undermine strategic goals. Several design principles, drawn from our experience and research, can help governments strike that balance.
First, effective FoF strategies require a clearly articulated dual mandate, comprising a coherent economic security objective and a credible commercial framework, anchored in enforceable structural constraints.
As part of their security mandate, FoFs should focus on strategically important sectors, such as AI, semiconductors, and autonomous systems, while clarifying whether the technologies are intended for defence, civilian capabilities, or both. They should support only companies that conduct research and development and maintain meaningful manufacturing activity in the target countries, rather than simply being legally domiciled there. For example, the support provided by Denmark’s Export and Investment Fund to the 55 North quantum fund highlights the government’s technological and security priorities.
On the commercial side, clear return targets for both FoFs and the underlying funds are needed to prevent security priorities from becoming an excuse for weak performance. They should also require minimum levels of private investment to ensure that private investors share risk and gradually take on a larger role as capital markets in priority areas mature.
Governments should also make the trade-offs they are willing to make between economic security goals and financial returns explicit from the outset, rather than allowing them to emerge later as political compromises. Over time, this balance may shift as private capital markets become capable of sustaining ecosystems on their own, or as some sectors strengthen while others emerge, requiring support on economic-security grounds.
Israel’s Yozma programme is a prime example, capping the state’s share of returns and allowing private investors to buy the government’s stake in successful funds. SVC took a different approach, waiving much of its carried interest to support ecosystem development, while the NATO Innovation Fund spreads its investments across multiple markets to strengthen capacity among member countries.
Second, governments must build security safeguards into the investment chain by ensuring that FoFs, underlying funds, and portfolio companies all operate within a framework that protects sensitive technologies and limits adversarial influence. In practice, FoF investment teams should hold appropriate security clearances, and in sensitive sectors, at least one general partner in each underlying venture fund should be vetted so that national-security authorities have a trusted point of contact. Effective security integration also means setting clear limits on adversarial capital, requiring investors to disclose the sources of limited-partner and co-investment funding, and scrutinising portfolio companies to identify opaque ownership structures and flag potential risks.
Moreover, FoFs can use their position as anchor investors to shape the policies of the venture funds they support. The NATO Innovation Fund, structured as a private investment vehicle but backed by allied governments, requires strong due diligence and transparency from the funds it selects, setting an effective security benchmark for investors across Europe’s defence, security, and resilience ecosystem. Such measures should become standard practice rather than special conditions applied only to a few funds. Lastly, well-designed FoFs can help establish and strengthen alliances. In a global economy defi ned by international innovators, intertwined supply chains, and cross-border capital flows, security cannot rely solely on national programmes. FoFs are uniquely suited to operationalising coalition strategies by linking allied economies while disentangling them from adversarial ones.
Multilateral platforms like the European Investment Fund’s regional vehicles show how pooled capital can align incentives across borders while spreading the costs of building strategic technological capacity. Similarly, the NATO Innovation Fund, by supporting FoF portfolio companies alongside its direct investments, helps build shared and interoperable defence and security capabilities among allies.
FoF efforts, however well designed, will fail if they focus solely on early-stage innovation. Ukraine’s early reliance on Chinese components, which limited its ability to capitalise on its own investments in drone innovation, should serve as a cautionary tale. True leverage lies not only in who invents new technologies but also in who controls large-scale production and critical supply chains.
For this reason, governments should consider expanding the FoF approach to support credible plans for scaling up manufacturing and facilitating investments in underlying supply chain capabilities and technologies. For example, government FoFs can back funds that finance the costly process of scaling up strategic industries, from semiconductor manufacturing to quantum hardware and advanced materials. Crucially, these strategies should align with other government measures, including coordinated public procurement, export controls, and subsidies.
FoFs are more than financial structures; they are a way for governments to connect capital, technology, and geopolitical power. When designed poorly, they risk sacrificing scarce public resources to the illusion that a handful of branded funds can substitute for the hard work of developing industrial capacity and sustaining long-term alliances. But when carefully designed, FoFs can help governments build resilient and strategically aligned innovation ecosystems without sacrificing market discipline.
Lars Frølund is a lecturer at the MIT Sloan School of Management. Fiona Murray is Professor of Entrepreneurship at the MIT Sloan School of Management and Chair of the NATO Innovation Fund.
