Chrysalis Investments’ (CHRY ) rehabilitation efforts took a dent today after the struggling Jupiter growth capital fund announced it would buy £20m shares in the unlisted Starling bank from its fund manager.

The move, which accompanied Jupiter’s announcement that it would unwind all unquoted positions from its open-ended funds, sent Chrysalis’ shares 6% lower as analysts said it increased the portfolio’s risks and raised questions over the independence of the board from Jupiter.

Stifel analyst Iain Scouller downgraded the investment trust to ‘sell’ from ‘hold’ saying with £20m of other planned follow-up investments, the transaction would reduce Chrysalis’ cash to £29m, or 4% of net asset value (NAV).

He described this as a ‘low cushion’ for a fund needing to support its pool of largely unquoted growth companies through an economic downturn and with capital markets currently closed to flotations.

Winterflood’s Emma Bird was concerned too with Chrysalis’ increased portfolio concentration with Starling set to become its largest holding, rising from 12% to 15% of assets.

She said this was ‘a risk which investors should monitor closely’ given Starling was a young business operating in one market, the competitive UK banking sector.

While Bird praised Jupiter’s decision to remove illiquid, unquoted stocks from its open-ended funds, and said the ‘closed-end structure’ of Chrysalis was clearly ‘more suitable’, the closeness of the investment company to its fund manager was under scrutiny.

Chrysalis is buying the additional shares in Starling from the £1bn Jupiter UK Mid Cap fund managed by its co-manager Richard Watts. For some, this may revive memories of 2019 when the then Woodford Patient Capital Trust bought stakes in unquoted companies from the Woodford Equity Income fund as it struggled with investors demand for a cash exit.  

Numis, one of Chrysalis’ two corporate brokers, expected ‘some mixed views from investors on this deal, with some likely to be more in favour of using excess cash to return of capital rather than fund new investments, given the 38% discount.’

However, analyst Ewan Lovett-Turner also expected more details on the rationale for the investment in a rapidly going business.

The fall in Chrysalis’ shares reversed an early rise after the board said the transaction could generate a ‘modest uplift’ in NAV per share if the company’s new independent valuation committee applied the ‘price of recent investment’ to its valuation of Starling.

Liberum, Chrysalis’ other broker, said the business bank was benefiting from improved lending margins after last year’s hike in interest rates: ‘The material improvement in Starling Bank’s financial performance through 2022 stands in stark contrast to the valuation of the business on Chrysalis’ balance sheet which has been reduced by more than 50% from its peak in March 2022.’

The broker noted Starling’s chief executive Anne Boden had reported the bank had generated annualised revenues and profits of around £600m and £250m in December, up from respective run rates of £331m and £92m in June.

The additional investment in Starling comes a week after Chrysalis released annual and first quarter results. The fund, which focuses on fast-growing private businesses looking to float, sought to highlight the strong underlying performance from most of its companies.

However, investors took fright at plans to dispose up to 19% of unprofitable companies, fearful of further write-downs which contributed to a 46% investment loss last year. Shares, which plunged 69% in 2022, had slid a further 9% before today’s news.

Explaining his decision to downgrade Chrysalis, Stifel’s Scouller said given its limited cash resources, concentrated portfolio and focus on earlier stage growth companies, ‘we think it should trade at a discount to the private equity funds sector. Given its risk profile, we argue that a 50% discount to NAV is more appropriate, resulting in a fair valuation of 64p.’

The shares traded 5.8% down at 75p.