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Eight of the 10 best-rated stock mutual funds inoculated themselves from the stock-market pandemic. They survived by neutralizing some market risk with long and short positions.

After excluding inverse and balanced funds, the most highly rated stock mutual fund is the

Arbitrage Fund

(ARBFX) - Get The Arbitrage Fund R Report

. It averaged an annual return of 4.07% over the three years ending Dec. 31 and earned a rating of A+.

As the fund's name implies, its managers seek acquisition target companies that sell for a discount to their announced sale price. A company buying another generally offers to pay more than the prevailing market price.

In the best-case scenario, if the sale is completed, the position can be liquidated for a profit. Or, in a typical merger-arbitrage transaction where the acquiring company offers stock instead of cash, the fund can buy the target company and simultaneously sell short an equivalent amount of the acquiring company. The difference between the amount paid for the target company's stock and the credit from the short sale is the gain for the trade before commissions, margin interest or other expenses. Once the trade is in place, the stock prices of the two companies tend to move in tandem, making the trade neutral to the overall market. If the acquiring company is forced to raise its offer, the transaction does even better.

When a proposed merger fails to happen, the arbitrage strategy can lose money. The Arbitrage Fund uses stock options and short selling to minimize market risk and volatility.

Also rated A+, the

JPMorgan Market Neutral Fund

(JMNAX) - Get JPMorgan Research Mrkt Neutral A Report

has averaged a 4.25% return over the past three years. Not only does the fund balance its portfolio of undervalued long positions with overvalued short sales to neutralize market risk, the managers also attempt to balance long and short weightings within each sector. At year-end, the fund was 11.7% long and 13.3% short health-care stocks, as well as 18.6% long and 21.5% short information-technology shares.

JPMorgan Market Neutral Fund's largest long positions include

Abbott Laboratories

(ABT) - Get Abbott Laboratories Report


TheStreet Recommends


(VZ) - Get Verizon Communications Inc. Report



(QCOM) - Get Qualcomm Inc Report


Walt Disney

(DIS) - Get Walt Disney Company Report

. On the short side are

Texas Instruments

(TXN) - Get Texas Instruments Incorporated Report



(INTC) - Get Intel Corporation Report


Johnson & Johnson

(JNJ) - Get Johnson & Johnson Report


International Business Machines

(IBM) - Get International Business Machines Corporation Report


The highest-rated stock fund not seeking a market neutral strategy is the

Forester Value Fund

(FVALX) - Get Forester Value Fund N Share Report

. Its value investing strategy eked out a 0.39% return last year, the eighth up year in the past nine.

The fundamental analysis strategy for this fund involves finding significantly undervalued companies to build a portfolio higher in earnings, assets and dividends per dollar of investment than the overall market. Forester watches for investor overreactions to bad news, resulting in low price-to-earnings, book-to-market, price-to-cash flow, and price-to-sales ratios. The fund lists


(WMT) - Get Walmart Inc. Report



(MCD) - Get McDonald's Corporation Report

as "bargain stocks that did well for the fund."

For more information, check out an

explanation of our ratings


Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.