New Star's new star?

EAGER investors have been piling back into shares since March, sending the FTSE 100 up more than 30%. Toby Thompson, manager of the New Star Higher Income fund since February 2002, joined the rally – but now he says some stocks have gone far enough.

When the FTSE 100 hit a six-year low in March, Thompson dumped safer stocks in favour of those that would benefit most from an economic recovery. The bet paid off. He still believes in that recovery, but says inflated hopes have pushed some stocks too high.

'It's not that I‘m negative about the economy,' he says. 'But the share price reaction looks like it has been overdone.'

Housebuilders are one example. Thompson has long dismissed predictions of a collapse in the UK property market and has remained a fan of shares in housebuilders. But he believes the rally in the sector has gone too far this year. In recent weeks he has sold his stakes in Barratt Developments and Wilson Connolly.

He has also dumped other stocks that flourish in recoveries – so-called 'cyclicals' – such as window locks and computer shields maker Laird and speciality chemicals firm Yule Catto. He has also taken profits from some retailers that have rallied. He has halved his stake in GUS, which owns Argos and credit checker Experian.

The money has been switched to so-called 'defensive' stocks, which have been largely unloved during this year‘s rally.

He has bought into drinks giant Diageo. The shares performed well in 2001 and 2002 when investors were seeking safe-havens and thought the popularity of the company‘s Smirnoff Ice brand offered promising growth opportunities. But investors gave the stock the cold shoulder as competition in the alcopops market grew and as they returned to racier shares.

'Now everyone says it's dull and the valuation, therefore, falls,' says Thompson. 'In my view, it can still generate a lot of cash and has reasonable growth.'

He also bought into airport operator BAA, and Rexam, which makes tins cans. Thompson says Rexam is growing profits at a reasonable rate. 'It's about finding companies that can deliver ahead of expectations,' he says.

The portfolio also contains Thompson's more established favourites: stockbroker and fund manager Old Mutual because of the 'attractive dividends' and 'good business model', and DFS Furniture. The retailer's shares are undervalued, he says, because investors are wrongly expecting a slowdown in the property market to hit DFS' sales.

He rules this out and says he is happy to collect an annual yield of 6% until the market revalues the shares.

Thompson's strategy is to invest only in stocks that yield more than the average for the UK stock market, which is currently around 3%. The fund yields around 4.4%. Charges are 5.25% upfront and 1.5% each year.

The £312m fund has returned 7.4% in the past year only marginally beating the average UK equity income fund.

Thompson's five-year track record at rival Newton was more impressive where he consistently ranked near the top of performance tables.

That achievement was enough for independent adviser Bestinvest to grant his New Star fund a 'buy' rating. Thompson is also ranked the third best UK equity income manager over five years on Bestinvest's fund manager ranking system.

Thompon also runs the Aberdeen Extra Income and Aberdeen High Income unit trusts, which were recently bought by New Star and are likely to be merged into the main fund.