Reflections on Establishing a Healthcare-Focused Fund of Funds by Shira Eting

Part 1: Reflections on Establishing a Healthcare-Focused Fund of Funds

We live longer and consume more healthcare solutions, our illnesses are becoming more chronic while our hospitals are not built for the current reality[1][2][3]. Physicians, nurses, and healthcare specialists are burned out and leaving the profession in great numbers[4]. National expenditure on health as a percentage of GDP has grown tremendously in recent decades and will continue to grow unless we make some radical shifts that will reduce cost of care and improve access to those underserved[5][6].

In the wake of this global health crisis, the imperative for innovation in healthcare has never been more important. Therefore, in 2022, following the immense tailwinds that emerged from Covid-19 together with technological enablers such as genome sequencing, AI, cloud, sensors and more, we at Vintage Investment Partners responded by launching our first sector-specific Fund of Funds (FoF), dedicated entirely to global healthcare funds. Two years into deploying about half of the fund among some of the leading managers in the space, this blog—the first in a two-part series—reflects on our establishment process and the initial strategies guiding our Fund of Funds. Stay tuned for the second part, where we will delve deeper into the specific healthcare sub-sectors and share the insights and learnings that are shaping our ongoing investment approach.

1. Setting up a sector-specific Fund of Funds has some major advantages…

In VC, only top-quartile funds generate returns that are “worth writing home about,” and it has been proven that on average – despite the disclaimers you might see on performance presentations – VC funds’ past performance is an indicator of future performance (source: Cambridge Associates). Therefore, LPs work hard to identify and get access to investors (funds or individuals) that have performed well historically. When we boil it down to specific KPIs, two things really matter: access (i.e., funds wanting you as an LP) and selection (i.e., choosing the right funds). We argue that focus helps with both.

Getting access to the best funds in the world is not easy. They are usually oversubscribed, tend to maintain a steady fund size (barring the recent bubble), and keep strong and stable relationships with existing LPs. To get access, a few things can help: developing a relationship, building expertise, a positive brand & reputation, and working hard through value-add. Having an internal team with sector expertise is beneficial, as it enables the team to identify nearly all relevant players and establish relationships with leading funds. The team develops deep knowledge of the specific market, including trends, success stories, business models, go-to-market strategies, and public market performance. This expertise helps deepen personal relationships with investors, create a reputation as a knowledgeable and serious Limited Partner (LP), and ultimately enhances the value of their investment in portfolio funds through strategic positioning and expertise.

Selecting the best funds is both art and science. While past performance is a strong indicator, it far from guarantees success. LPs diligently assess team dynamics, strategy, portfolio quality, execution, and brand before making an investment. Having a sector focus provides familiarity with the ecosystem leading to improved pattern recognition, and enhanced due diligence capabilities

2.…But needs to be done carefully as it has limitations.

Not all sectors are created equal and while some hold big promise, others might underperform. When choosing to focus on a sector, four things matter – Total Addressable Market (TAM), diversification, maturity and required expertise (i.e., funds’ ability to create alpha).

First, LPs must ensure the sector’s TAM is big enough so there is room for enough successful companies to be built and enough funds to choose from. Healthcare in the US alone is a $4T industry that can be broken into hundreds of smaller markets. At Vintage, we researched more than 100 healthcare-focused funds before we made our first fund investments and plan to invest in very few to achieve top decile returns.

LPs should also make sure the sector is diverse enough with multiple types of technologies and G2M motions, so that if one underperforms, others can compensate. Healthcare technologies encompass Life Sciences (i.e., therapeutics, diagnostics), Medical Devices, Digital Health (i.e., how we deliver solutions to patients) and Tech-Bio (i.e., convergence of biology and technology). Technologies can address multiple types of potential customers, including pharma, providers, payers, employers & consumers, and each bucket can be further dissected into multiple sub-markets. Importantly, we made sure to have exposure to all, while placing emphasis on portfolio construction, as will be discussed below.

Third, the sector must demonstrate sufficient maturity. Establishing a Fund of Funds focused on an emerging sector can be highly rewarding but also carries significant risks due to the uncertainty of successful investments and the limited number of proven investors. In Healthcare, Life Sciences is a well-established market, Digital Health has experienced significant growth, particularly during the Covid boom, and Tech-Bio is still an emerging field, so we have chosen to diversify across all of these to balance the more mature areas with the up-and-coming ones.

Last, the chosen sector should require deep investment expertise that provides dedicated investors with a tangible advantage over generalists. Generalists pose a big threat to sector-specific funds when competing for the best companies. If a sector-specific fund does not have major advantages in sourcing, diligencing, winning and value-add, then FoFs are probably better off getting that exposure from generalist investors. Since Healthcare is very much driven by deep scientific capabilities (especially in Life Sciences and Tech-Bio), and Digital Health is a very difficult system to navigate, we are convinced that dedicated investors are better positioned to succeed.

3. Portfolio construction is key

At Vintage, we hold a fundamental belief that venture capital does not scale. Given that only a limited number of investments can yield outsized returns, it is essential for funds to remain modest in size to achieve top-quartile returns or better. Therefore, we began with a modest $50 million Fund of Funds, which equates to approximately 10 fund investments, ensuring we maintain discipline and aim for that top-decile. Additionally, predefining the fund’s construction regarding check size, sub-sector, and geographic exposure aids in managing risk and reward. While this framework should remain flexible and adjustable over time, having a clear initial structure is a critical step in guiding the strategy.

In terms of check size, we aimed to allocate approximately 80% of the capital to core relationships, which involves issuing large checks to 6-7 proven funds, and the remaining 20% to 2-3 emerging managers. This strategy allows the core investments to drive performance while also providing exposure and access to the sector’s future leaders.

For sub-sector allocations, we categorized funds into pure Life Science, Digital Health, and Tech-Bio, deciding on exposure levels of 30%, 50%, and 20%, respectively. We invested less in Tech-Bio because, despite its high potential as an emerging field, it is less proven. The second part of this blog will provide more color on our sub-sector thesis.

Geographically, Vintage invests in North America, Europe, and Israel. Each market offers distinct advantages and challenges, but we have allocated a larger portion of our investments to the U.S. due to its more “proven” status, evidenced by its longer track record of performance, larger talent pool, and greater number of funds and companies. However, we are always on the lookout for new, emerging players with investment experience in each geography and sector.

4. As well as a slower deployment pace

Compared to our other Fund of Funds (FoF) vehicles, the deployment of our Healthcare FoF has been more gradual. While we have been developing relationships in the sector for many years, initial commitments to a fund invariably require more time than subsequent reinvestment decisions. Our commitment to long-term success guides our decision-making. We prioritize making the right choices over rapid decisions, as evidenced by our core commitment re-up rate exceeding 90%. Additionally, a slower deployment pace aids in diversifying across vintage years.

5. And we followed a playbook to refine our fund selection and value-add
We initiated our process by engaging with as many funds as possible, quickly identifying those that have great teams, returns, and align well with Vintage’s investment philosophy. We focused on strengthening our relationships with these selected funds. Concurrently, we built an expert network comprising various stakeholders in the value chain, such as pharmaceutical companies, providers, payers, along with bankers, corporate venture capitalists (CVCs), and other LPs.

We systematically mapped all funds based on their sub-sector, stage, and geographical focus, and evaluated them against each other using key metrics. This structured approach was crucial in developing our investment conviction and refining our investment thesis.

In terms of value-add, a fundamental principle at Vintage, we utilize our Value+ unit to facilitate connections between corporates and startups at no cost. Our growing Healthcare expert network and our deep sector insights are pivotal in fostering innovation. We actively facilitate introductions between startups, funds and potential customers, provide insightful feedback to our portfolio funds, and take Limited Partner Advisory Committee (LPAC) positions in emerging managers to help them with best practices, etc.

In this first instalment, we have laid the groundwork by discussing the initiation and strategic direction of our healthcare-focused Fund of Funds. Highlighting our response to the pressing needs in healthcare and our commitment to innovative investment. On the second part of this series, we will delve into specific healthcare sub-sectors such as Life Sciences, Digital Health, and Tech-Bio, sharing key insights that guide our investment strategy moving forward.

[1] Adding Years to Life and Life to Years, McKinsey Health Institute, March 2022

[2] World Health Statistics 2023, WHO Global Report, May 2023

[3] UnHealthcare: A Manifesto for health Assurance, Hemant Taneja, Stephen Klasko, Kavin Maney, May 2020

[4] Beyond Burnout: Why Physicians are Leaving their Jobs in Droves, DHI, October 2023

[5] Health expenditure as a percentage of GDP in selected countries in 2022, Statista, September 2023

[6] How does Health Spending in the US Compare to Other Countries?, Health System Tracker, Jan 2024