Top-Rated Stock Funds Stay Market Neutral

TSC Ratings provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking solid outperformance on a total return basis.

The 10 best-rated stock mutual funds as of April 30 used so-called "market-neutral" strategies to smooth out the choppy market.

Market-neutral mutual funds attempt to minimize volatility by taking long and short positions. These funds earned our top rating of A-plus. Each fund has at least 50% exposure to equities.

The JPMorgan Market Neutral Fund(JMNAX Quote) led the group, returning 5.4% a year, on average, for the past three years. The fund has gained 4.3% in the past year as the S&P 500 Index dropped 33%.

This fund takes short interest in mid- and large-cap stocks it considers overvalued, betting the shares will lose value. It takes long stakes in stocks viewed to be cheap.

The long positions, which add to net asset value as they rise, include Northrop Grumman (NOC Quote), Altria Group (MO Quote) and Google (GOOG Quote). These stocks have climbed more than 10% in the past three months, with defense contractor Northrop Grumman gaining 27%.

JPMorgan Market Neutral Fund had hoped to gain from its largest short positions as their share prices fell. However, Johnson & Johnson (JNJ Quote), Comcast (CMCSK Quote) and H.J. Heinz (HNZ Quote) have risen as much as 12% in the past three months, dragging down the short side of the portfolio.

The Arbitrage Fund(ARBFX Quote), the No. 2 stock fund, returned 4.2% a year, on average, in past three years by placing merger arbitrage bets involving takeovers, leveraged buyouts, tender offers and other reorganizations.

In an arbitrage transaction, investors buy shares of a company targeted for acquisition at a discount to their announced sale price. At the same time, the investor takes a short position of the acquiring company. The arbitrage strategy can lose money if the merger doesn't close.