Fund of funds (FoF) are increasingly used to shape how governments practice economic policy. When designed well, they pool capital to invest in venture capital funds rather than directly into individual companies or securities, strengthening innovation ecosystems while guiding investments toward strategically important markets, capabilities, and technologies. But when poorly designed—often the case—these structures reproduce the well-known failures of investment programs captured by political incentives.
Over the past three decades, public FoFs have mainly been employed as tools to draw private investors into early-stage venture capital markets, especially in countries with limited national capacity. The best-known example is Israel’s Yozma program, launched in 1993, but later approaches were adopted by Australia’s Innovation Investment Fund, the European Investment Fund, and the Saudi Venture Capital Company (SVC). Each of them used the FoF model to broaden the supply of venture capital.
FoFs as a geopolitical instrument
That era was drawing to a close, as governments increasingly use FoFs to steer capital toward critical national capabilities and strategic technologies (often dual-use), sidestep hostile or high-risk investors, and develop innovation capacity both domestically and in allied countries. The United Kingdom’s National Security Investment Fund and Denmark’s 55 North quantum fund are notable examples. On a multilateral level, both the European Investment Fund’s European Champions Initiative and NATO’s Innovation Fund (backed by twenty-four members) reflect this shift.
“The question is whether governments should use FoFs […] in a way that national security priorities do not erode market discipline and commercial logic does not undermine strategic objectives”
Consequently, the question is no longer whether governments should use FoFs to advance economic diplomacy, but how to design them so that national security priorities do not erode market discipline and commercial logic does not undermine strategic objectives. Several design principles, drawn from our experience and research, can help governments achieve that balance.
First, effective FoF strategies require a clearly articulated dual mandate, comprising a coherent objective of economic security 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 technologies are intended for defense, civilian applications, or both. They should support only companies that engage in research and development activities and maintain significant manufacturing in the recipient countries, rather than merely being legally domiciled there. For example, Denmark’s Export and Investment Fund’s support for the 55 North quantum fund highlights the government’s tech and security priorities.
On the commercial side, there is a need for clear profitability objectives for both the FoFs and the underlying funds, to prevent security ambitions from becoming a pretext for weak performance. They should also require minimum levels of private investment to ensure private investors share the risk and gradually assume a larger role as capital markets in priority areas mature.
Governments should also lay out from the outset the trade-offs they are willing to accept between economic-security goals and financial returns, rather than letting them emerge later as political commitments. Over time, this balance may shift as private capital markets become capable of sustaining ecosystems on their own, or as certain sectors strengthen while others emerge, necessitating security-based support.
Israel’s Yozma program is a paradigmatic example, as it limits the government’s stake in returns and allows private investors to buy the government’s share in successful funds. SVC took a different route, surrendering a large portion of its share of profits to back ecosystem development, while NATO’s Innovation Fund distributes its investments across multiple markets to bolster member-country capabilities.
“Governments must embed security safeguards in the investment chain, ensuring FoFs operate within a framework that protects sensitive technologies and limits adversarial influence”
Secondly, governments should embed security safeguards throughout the investment chain, ensuring that FoFs, the underlying funds, and portfolio companies operate within a framework that protects sensitive technologies and curbs adversarial influence. In practice, FoF investment teams should hold appropriate security clearances, and in sensitive sectors, at least one general partner of each underlying venture capital fund should undergo a verification process so that national security authorities have a trusted contact point. An effective security integration also entails setting clear limits on hostile capital, requiring investors to disclose the funding sources of sponsors and co-investors, and conducting thorough scrutiny of portfolio companies to identify opaque ownership structures and flag potential risks.
Furthermore, FoFs can use their position as lead investors to influence policy within the venture capital funds they back. NATO’s Innovation Fund, structured as a private investment vehicle but backed by allied governments, imposes rigorous due diligence and transparency on the funds it selects, establishing a robust security benchmark for investors across Europe’s defense, security, and resilience ecosystem. These measures should become standard practice, rather than special conditions applied only to a few funds.
Finally, well-designed FoFs can help establish and strengthen alliances. In a global economy characterized by international innovators, tightly linked supply chains, and cross-border capital flows, security cannot rely on national programs alone. FoFs are particularly well-suited to implement coalition strategies by tying allied economies together while keeping them distinct from adversaries.
Multilateral platforms, such as the European Investment Fund’s regional vehicles, illustrate how shared capital can align cross-border incentives while spreading the costs of building strategic technological capabilities. Similarly, NATO’s Innovation Fund, by supporting portfolio companies alongside its direct investments, helps create shared and interoperable defense and security capabilities among allies.
“Ukraine’s initial reliance on Chinese components, which limited its ability to benefit from its own drone-innovation investments, should serve as a warning”
FoF initiatives, no matter how well designed, will fail if they focus solely on early-stage innovation. Ukraine’s initial reliance on Chinese components, which constrained its ability to capitalize on its own drone-innovation investments, should serve as a warning. The real 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 remit to support credible plans for scaling up manufacturing and enabling investments in underlying supply-chain capabilities and technologies. For instance, FoF-backed funds could finance the costly process of expanding strategic industries—from semiconductor fabrication to quantum hardware and advanced materials. It is essential that these strategies 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. If designed poorly, they risk sacrificing scarce public resources to the illusion that a handful of branded funds can replace the hard work of building industrial capacity and sustaining long-term alliances. But when carefully crafted, FoFs can help governments build resilient, strategically aligned innovation ecosystems without sacrificing market discipline.
© Project Syndicate, 2026.
