Strategic capital is reshaping economic security
Funds of funds align profit with priorities
Smart design unlocks resilient innovation ecosystems
In an era marked by increasingly complex interdependence, the relationship between capital, technology, and national security is undergoing a quiet but consequential shift. Global supply chains remain deeply intertwined, cross-border capital flows continue to shape economic outcomes, and technological capabilities have become central to both prosperity and sovereignty. Within this evolving context, governments are reassessing how financial instruments can serve broader strategic objectives—without compromising market integrity.
Among the tools gaining prominence is the fund of funds (FoF) model. Traditionally viewed as a mechanism to stimulate venture capital ecosystems, FoFs are now being repositioned as instruments of economic statecraft. Their potential lies not merely in mobilizing capital, but in directing it with purpose—toward sectors and capabilities deemed critical for long-term national and regional resilience.
From Market Development to Strategic Alignment
Historically, public FoFs were designed to address a clear gap: the lack of early-stage venture capital in emerging or underdeveloped markets. By pooling public and private capital and investing in venture funds, governments were able to catalyze entrepreneurial ecosystems and crowd in private investors. Israel’s Yozma program remains the most cited example, having successfully seeded a now globally recognized innovation ecosystem. Similar models were later adopted across different jurisdictions, including Europe, Australia, and parts of the Gulf.
These initiatives were largely commercial in orientation. Their primary objective was to generate returns while fostering domestic investment capacity. Over time, many succeeded in achieving both aims. However, the global environment in which they operated has changed significantly.
Today, the focus is no longer confined to market development. Governments are increasingly concerned with the strategic implications of capital allocation—particularly in sectors such as artificial intelligence, semiconductors, advanced materials, and autonomous systems. These are not merely high-growth industries; they are foundational to economic security and, in many cases, national defense.
As a result, FoFs are being recalibrated to serve dual purposes: advancing economic security while maintaining commercial discipline. This shift reflects a broader recognition that capital markets, left entirely to their own logic, may not always align with national or regional priorities.
Designing for Dual Objectives
The central challenge lies in balancing two distinct but interconnected mandates. On one hand, FoFs must operate within a credible commercial framework to ensure efficiency, accountability, and long-term sustainability. On the other, they must support clearly defined strategic objectives that may not always yield immediate financial returns.
Achieving this balance requires deliberate design. First, governments must articulate a coherent economic security strategy that identifies priority sectors and technologies. This involves not only selecting areas of investment but also clarifying the intended outcomes—whether related to defense capabilities, civilian applications, or a combination of both.
Equally important is ensuring that supported companies contribute meaningfully to domestic or allied economies. This goes beyond legal domicile. It requires tangible commitments to research, development, and manufacturing within target jurisdictions. Without such criteria, capital risks flowing into entities that offer limited strategic value.
From a commercial perspective, clear return expectations are essential. FoFs should establish performance benchmarks for both the funds they invest in and the underlying portfolio companies. This is not merely a financial consideration; it is a safeguard against the erosion of discipline that can occur when strategic objectives dominate decision-making.
Private sector participation also plays a critical role. By requiring co-investment from private investors, FoFs can ensure that risk is shared and that market signals remain relevant. Over time, as ecosystems mature, the reliance on public capital should diminish, allowing private markets to assume a greater role.
Transparency in trade-offs is another key consideration. Governments must be explicit about the balance they are willing to strike between financial returns and strategic outcomes. This clarity helps manage expectations and reduces the likelihood of ad hoc adjustments driven by political pressures.
Different models illustrate how this balance can be achieved. In some cases, governments have capped their share of returns to incentivize private investors to assume greater ownership. In others, they have prioritized ecosystem development over immediate financial gain. Multilateral approaches, meanwhile, have sought to distribute investments across allied markets, reinforcing collective capacity.
Embedding Security Across the Investment Chain
As FoFs take on a more strategic role, the integration of security considerations becomes indispensable. This extends beyond high-level policy and into the operational fabric of the investment process.
At the fund level, governance structures must ensure that decision-makers are equipped to assess not only financial risks but also security implications. In sensitive sectors, this may involve vetting key personnel and establishing secure channels of communication with relevant authorities.
Transparency is equally critical. Investors—both domestic and international—should be required to disclose the origins of their capital. This enables authorities to identify and mitigate the influence of actors whose interests may not align with national or regional priorities.
Portfolio companies, too, must be subject to rigorous scrutiny. Complex ownership structures, opaque funding arrangements, and indirect links to high-risk jurisdictions can all pose challenges. FoFs, particularly when acting as anchor investors, are well positioned to set standards for due diligence and governance across the funds they support.
This influence should not be underestimated. By embedding robust requirements into their investment criteria, FoFs can shape the behavior of venture capital markets more broadly. Over time, such practices can contribute to the establishment of industry-wide norms that balance openness with prudence.
Strengthening Alliances Through Capital
One of the most compelling attributes of the FoF model is its capacity to operate across borders. In a world where economic and technological ecosystems are increasingly interconnected, national approaches alone may prove insufficient.
FoFs offer a practical mechanism for aligning investment strategies among allied countries. By pooling capital and coordinating priorities, governments can support shared objectives while distributing both risk and reward. This is particularly relevant in areas where the scale of investment required exceeds the capacity of any single country.
Multilateral initiatives have already begun to demonstrate this potential. By investing in funds that operate across multiple jurisdictions, these platforms facilitate the exchange of knowledge, the development of complementary capabilities, and the creation of more resilient supply chains.
For the Arab region, where economic integration remains an ongoing objective, such approaches hold significant promise. Coordinated investment strategies could help bridge gaps between markets, support the development of regional champions, and enhance collective competitiveness.
Beyond Innovation: The Imperative of Scale
While much of the discussion around FoFs has focused on early-stage innovation, this represents only part of the equation. The ability to develop new technologies is important, but it is equally critical to retain control over their production and distribution.
Recent geopolitical developments have underscored the risks associated with fragmented supply chains. Even where countries possess strong innovation capabilities, reliance on external suppliers for key components can limit their strategic autonomy.
For this reason, FoFs should be considered as part of a broader framework that includes support for manufacturing and supply chain development. This may involve backing funds that specialize in scaling industrial capacity, financing infrastructure, or enabling the commercialization of advanced technologies.
Such efforts must be aligned with other policy instruments. Public procurement, for example, can provide stable demand for emerging industries. Export controls can protect sensitive technologies, while targeted incentives can encourage investment in priority areas.
The objective is not to replace market mechanisms, but to guide them in ways that reinforce long-term resilience.
Implications for the Arab Financial Sector
For Arab economies, the evolving role of FoFs presents both an opportunity and a responsibility. The region is home to significant pools of capital, a growing base of entrepreneurial talent, and an increasing focus on technological development. At the same time, it faces structural challenges related to diversification, employment, and integration into global value chains.
Strategically designed FoFs could help address these challenges by channeling capital into sectors that align with national and regional priorities. They could also serve as platforms for collaboration among sovereign wealth funds, development finance institutions, and private investors.
However, success will depend on careful execution. Without clear mandates, robust governance, and strong alignment between stakeholders, such initiatives risk falling short of their potential.
A Forward-Looking Perspective
As the global economic landscape continues to evolve, the intersection of finance and strategy will become increasingly pronounced. Funds of funds, once viewed as technical instruments within the venture capital ecosystem, are now emerging as tools with broader significance.
Their effectiveness will ultimately be determined by the clarity of their purpose and the rigor of their design. When these elements are in place, FoFs can contribute to the development of innovation ecosystems that are both competitive and resilient.
For Arab banks and financial leaders, the path forward is clear yet demanding. It requires embracing a more strategic approach to capital allocation—one that goes beyond short-term returns and considers the long-term positioning of economies within a changing global order. Institutions should actively participate in or partner with FoF structures that align with national priorities, advocate for transparent and disciplined governance frameworks, and support initiatives that strengthen regional collaboration. By doing so, they can play a pivotal role in shaping an economic future that is not only prosperous, but also secure and sustainable.
