Portfolio construction: How to develop a fund strategy

Portfolio construction: How to develop a fund strategy

Author: The Carta Team
Read time:  4 minutes
Published date:  April 30, 2024
Updated date:  April 30, 2024
Portfolio construction is your venture fund's roadmap. Learn what to include and how to build your first fund strategy.

It goes without saying that becoming a successful venture capitalist is challenging and competitive. Without a clear investment thesis and effective portfolio construction strategy, it’s difficult to convince investors to make a commitment to your fund.

What is portfolio construction?

For private equity and venture capital (VC) fund managers, portfolio construction is a multi-step process that helps show your investors how your fund will maximize returns. A thoughtful portfolio construction strategy (often referred to as simply your fund strategy) is critical to success.

Your portfolio construction model is a roadmap for the life of your fund. It gives your LPs ( limited partners) insight into how you plan to allocate capital, including forecasts for:

  • How much you’ll set aside for initial investments

  • The number of companies you’ll invest in (your investment portfolio)

  • The amount of capital you’ll invest into each company (your inputs)

  • Your target ownership for each company (your weightings)

  • How much you’ll reserve for follow-on investments

What to include in your portfolio construction strategy

Your fund strategy should touch on the following elements:

  • General portfolio strategy, including your investment thesis

  • Diversification & asset allocation

  • Different asset classes & volatility

  • Check size

  • Investment time horizon

  • Expected returns/investment objectives

  • Investor requirements

  • Deal sourcing

  • Due diligence

Rebalancing your strategy

You need to evolve your portfolio construction model as market conditions change. As you gain more visibility into your portfolio, set aside time to regularly evaluate whether or not your investments align with your original model to reach your fund’s financial goals. If your investments deviate from your original thesis, you will need to adjust your model or reset your focus. 

How to build a solid portfolio construction

To compete with other venture capital funds, you need to be able to differentiate yourself while creating a plan that’s realistic and sustainable. Your fund strategy should align with your capabilities, network, market opportunities, and LP interests. 

Step 1: Determine your minimum viable fund size

As venture capitalist Mark Suster has written, your fund size is your strategy. The size of your fund influences almost every element of your investment strategy: the number of companies in your portfolio, your check size, the amount of reserve capital you have, the LPs you attract, and the return profile for your fund. Your fund size also determines your management fees, which then dictate the operational expenses you can realistically support. 

To determine your ideal fund size, start by researching funds with goals and benchmarks like yours to see how they’re faring. You may also want to research successful funds across a handful of different industries and sectors to see what works.

Step 2: Scenario modeling

Do a pricing model to map out your fund’s potential financial constraints and growth. What size investments do you plan to make? How many investments do you need to make over the course of a year to generate significant returns? What about over the life of the fund? Plugging in possible numbers and scenarios will give you a better idea of the fund size that makes the most sense for you and your portfolio risk tolerance.

Step 3: Pinpoint your investment focus

Once you’ve settled on a fund size, the next step is to outline the stage, sectors, and types of founders you’ll invest in. Articulating your investment focus doesn’t just help you to narrow your aim and convince the right LPs to get on board, it also makes it easier for founders to self-qualify and approach you for guidance. 

When you’re defining your focus, consider the following: 

  • Industry: Which sectors are you interested in? Do you plan to target a specific industry like healthcare, or focus on similar companies across a handful of different industries? 

  • Stage: At what point in a company’s life cycle do you want to invest and offer guidance? If you’re interested in being a sounding board for founders who are just getting started, you might want to invest at the seed stage. However, if you prefer to work with companies that already have steady revenue and an established business model, you’ll probably want to jump in at a later stage.  

  • Geography: Where are the companies you’ll be investing in? What particular challenges and assets do they have because of where they operate? You may choose to invest in local companies if you already have a network of contacts nearby. On the other hand, if you’re open to traveling or want to capitalize on lesser-known markets, you may want to expand your reach.  

Special considerations: Depending on your investment goals, you might have other criteria to look at, like a company’s social impact, environmental influence, or commitment to diversity, equity, and inclusion.

Portfolio construction tools

While there’s no “one size fits all” approach to portfolio construction, Carta’s Fund Formation services can guide you through every step of starting your fund. While we recommend working with your financial advisor and lawyer, Carta can help form your fund, administer the first close, and execute your initial capital call—all in six weeks.

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The Carta Team
While we believe in assigning ownership at Carta, this blog post belongs to all of us.
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