Portfolio construction: How to develop a fund strategy

Becoming a successful fund manager is challenging and competitive. Without a clear investment thesis and effective portfolio construction strategy, it’s difficult to convince institutional investors to make a commitment to your fund.

What is portfolio construction?

Portfolio construction is the multi-step process of designing an investment strategy to achieve a fund's specific goals. It is the blueprint a general partner (GP) creates to select the right mix of investments that will balance portfolio risk and maximize returns for their investors, known as limited partners (LP). This process involves determining how to allocate assets to meet the fund's objectives within a defined risk tolerance and investment horizon. A thoughtful portfolio construction strategy (often referred to as simply your fund strategy) is critical to success.

Instead of simple security selection, you are architecting the entire investment vehicle from the ground up. Your portfolio construction model becomes the core of your pitch to LPs, demonstrating that you have a disciplined and well-reasoned plan for how you will invest their capital. It is the quantitative proof behind your qualitative story. It includes 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

For alternative investments in private funds, this concept takes on a unique meaning. For a venture capital (VC) or private equity (PE) manager, portfolio construction is about defining the fundamental parameters of the fund itself, including how much capital to raise, how many companies to back, and how to allocate that capital over the fund's multi-year lifespan. Your fund strategy should touch on the following elements:

• General portfolio strategy, including your investment thesis

• Diversification and strategic asset allocation

• Different asset classes and market volatility

• Check size

• Investment time horizon

• Expected returns/investment objectives

• Investor requirements

• Deal sourcing

• Due diligence

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How portfolio construction differs for private funds

While the goal of building a strong portfolio is universal, the construction of that portfolio in private funds operates under a completely different set of rules than in public markets. The nature of the assets, the availability of information, and the time horizons are fundamentally distinct. Understanding these differences is the first step to building a successful private fund strategy.

These differences are critical for fund managers to understand as they develop their strategy.

These distinctions (especially the lack of liquidity, reliable data, and sector-specific execution risks) mean that a private fund portfolio construction strategy cannot simply be a copy of a public capital market model. You must plan for a multi-year journey with each investment, where success is not measured in daily price changes but in the eventual growth and exit of a company.

The private fund portfolio construction process

For a new fund manager, understanding how to approach portfolio construction can feel overwhelming. The key is to break it down into a clear, step-by-step process. This structured approach can make the complex task feel more manageable and actionable, turning a daunting challenge into a series of logical decision-making steps.

Step 1: Develop an investment thesis

Every strong portfolio begins with a clear investment thesis. This is the fund's story and its unique point of view on the market, providing the discipline to guide every investment selection. It is the qualitative narrative that serves as the essential foundation upon which the quantitative fund model is built.

A well-defined thesis answers critical questions for potential LPs, such as:

• What specific industry, technology, or stage will the fund focus on?

• What is the manager's unique expertise or network that provides an edge in sourcing deals?

• Why is now the right time for this particular strategy? A strong thesis might signal market trends, such as the potential for upward momentum on VC allocations after a recent performance trough.

Your thesis provides constant guidance. It keeps you focused and helps you explain to LPs what you invest in and why you are the right person to be making those investments.

Step 2: Model the fund strategy

This step is where the investment thesis is translated into a financial model. Without a dedicated platform, managers have been forced to build these models in complex, error-prone spreadsheets. The process is especially difficult for active funds, where calculating the value of unrealized gains is tricky and lacks a widely accepted industry standard for how to value their investments.

Modern solutions offer a more dynamic and professional alternative. As Carta’s Anubhav Srivastava muses during the Fund Forecasting Demo webinar: "Portfolio construction is painful. I don't want to spend four weeks building a complicated Excel model." Instead of a static spreadsheet, managers can use a platform like Fund Forecasting to model different scenarios, adjust assumptions in real time, and build a defensible, institutional-grade plan that gives LPs confidence.

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Step 3: Execute and manage the portfolio

Once the fund is launched and capital is raised, the focus shifts from the initial construction to the ongoing execution and portfolio management. This involves deploying capital according to the plan, monitoring company performance, and handling all the operational duties of running a fund.

Every investment decision has a downstream operational impact, including calling capital from LPs and managing financial reporting and tax compliance. This highlights the importance of a robust back office and an integrated fund management system to manage these complexities, setting the stage for why a comprehensive solution like Carta Fund Administration is essential for long-term success. Without a solid operational foundation, even the best-constructed portfolio can falter under administrative weight.

Step 4: Rebalancing your strategy

As part of your ongoing investment management, you may need to evolve and optimize 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.

Key levers of private fund portfolio construction

To compete with other 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.

When modeling a fund, you have several key levers you can pull. Each lever represents a critical trade-off, and understanding how they interact is the art of constructing an effective investment portfolio. Getting these variables right is essential to aligning your strategy with your thesis and your LPs' expectations.

Fund size

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. A larger fund allows for more investments but also requires a larger team and a more extensive deal flow pipeline.

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, including real estate and tech, to see what works.

Number of investments and target ownership

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.

This is the classic tradeoff between diversification and concentration. For venture capitalists, one of the biggest determinants of fund performance is having enough "shots on goal." This diversification strategy is reflected in how funds of different sizes build their model portfolios. For example, data from the 2019 vintage shows a significant gap in the median number of investments: The median fund larger than $100 million invested in 42 companies, while the median fund between $1 million and $10 million made just 18 investments.

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 lifecycle 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.

Depending on your investment goals, you might have other criteria to look at, like a company’s ESG impact, environmental influence, or commitment to diversity, equity, and inclusion (DEI).

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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 level of risk tolerance.

Follow-on strategy and reserve capital

Reserve capital is the portion of the fund set aside for future investments in existing portfolio companies, called follow-on investments. The strategic debate is whether to use reserves to double down on your best-performing companies or to deploy all your capital into new initial investments. Using Fund Forecasting software helps firms like Starport Capital model these different strategies to see the potential impact on fund returns and make data-driven decisions.

Capital recycling

This is the practice of reinvesting the proceeds from early exits back into new investments. While it can increase a fund's investable capital, data on fund spending suggests that significant recycling during the investment period is less common than often assumed. For example, after eight years, the median fund from the 2017 vintage had spent a total of 106% of its committed capital—87% on investments and 19% on fees and expenses. This indicates that while some funds have recycled capital, the median amount is modest, providing a realistic benchmark for new managers and helping to temper overly optimistic financial modeling assumptions.

Explore alternative liquidity paths

Managing a portfolio over a decade-long fund life means that providing liquidity for your LPs is a constant strategic consideration. While traditional exits like IPOs or acquisitions are the primary goal, market conditions can shift. Understanding alternative liquidity paths is crucial for modern fund managers. One increasingly popular strategy is the GP-led secondary, which can help you deliver returns to investors and better manage your portfolio's timeline.

From construction to management: Tracking fund performance

It's important to distinguish between portfolio construction and portfolio management. Portfolio construction is the plan you create before you invest, while portfolio management is the ongoing process of tracking your performance against that plan. Your initial model is a hypothesis; portfolio management is the process of testing that hypothesis against reality.

Effective portfolio management requires a single source of truth where actual investment data—like cash flows and valuations—is continuously updated. This allows you to see if you are on track with your deployment schedule and how the fund's projected returns are evolving.

For firms like Trust Fund, moving beyond a static, initial plan was key. Trust Fund uses Fund Forecasting to build dynamic models that evolve with the fund, giving them a live view of performance.

This real-time feedback loop is invaluable. It allows you to make more informed decisions about follow-on investments, manage your cash reserves, and communicate more effectively with your LPs about how the fund is progressing.

Building a defensible fund strategy with an integrated platform

A thoughtful portfolio construction plan is necessary, but it's not sufficient for success in today's competitive market. To truly build an institutional-grade firm, you need an integrated technology platform that connects your strategic model to your daily fund operations. This creates a seamless system where your plan informs your actions, and your actions update your plan.

Carta provides this unified platform. It creates a seamless workflow from planning with Fund Forecasting, to launching the fund with Fund Formations or SPVs, to running the back office with Carta Fund Administration. This integrated approach provides the control, visibility, and efficiency that both managers and their LPs demand, turning fund administration from a cost center into a strategic advantage.

When your strategy, operations, and reporting are all connected on a single platform, you can focus on what you do best: finding and supporting the next generation of great companies.

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Frequently asked questions about portfolio construction

What is a good return for a VC fund?

LPs typically look for a fund to return a multiple of their invested capital. While a total value to paid-in capital (TVPI) of 3x is often considered the mark of exemplary performance, data on more mature funds provides a realistic benchmark. For example, recent VC fund performance data shows that among funds from the 2017 vintage, the median net TVPI is 1.76x, while funds in the 75th percentile reached a 2.27x multiple.

How can I build an investment track record before raising a fund?

While angel investing is one path, launching a special purpose vehicle (SPV) is a professional and scalable way to build a verifiable track record.

How does the power law impact venture portfolio construction?

The power law principle means a small number of investments will generate most of a fund's returns. Because of this, your portfolio must be constructed to maximize the chances of finding and investing in these rare, outlier companies that can return the entire fund.