Eight of the 10 best-rated stock mutual funds employ variations on market-neutral strategies, which tend to work better in bear markets.

One balances stocks with currencies and gold, and the other went into cash as the manager waits for the market to bottom before jumping back into domestic growth stocks. All of the funds earned a rating of A-plus for the period ending Feb. 27.

The best-rated stock mutual fund last month, when the benchmark S&P 500 index fell more than 100 points to about 700, was the JPMorgan Market Neutral Fund ( JMNAX), averaging a return of 5.4% over the past three years. Market-neutral funds can use long and short positions on stocks to balance overall market risk. This fund looks for mid- and large-capitalization stocks considered to be overvalued for short sales and balanced against undervalued stocks to buy within the same sector.

Favored long positions, which make money for the fund's shareholders as they rise, include Abbott Laboratories ( ABT), Verizon Communications ( VZ) and Qualcomm ( QCOM). Some of the largest short positions from which the JPMorgan Market Neutral Fund hopes to gain as their share prices sink include Texas Instruments ( TXN), Johnson & Johnson ( JNJ) and Intel ( INTC).

The second-best-rated fund was the Arbitrage Fund ( ARBFX), which posted an average annual return of 4.18% over three years by placing merger-arbitrage bets on publicly announced takeovers, leveraged buyouts, tender offers and other reorganizations.

The fund's manager seeks acquisition target companies that sell for a discount to their announced sale price. When one company proposes to buy another they generally offer 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. When the acquiring company is offering stock instead of cash, the acquiring company can be sold short simultaneously with buying the target in an arbitrage transaction to immediately pocket the difference.

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.

The most highly rated stock fund that doesn't follow a market-neutral strategy is the Permanent Portfolio ( PRPFX). The fund uses categorical diversification in gold, silver and Swiss franc assets to balance equity risk from real estate, natural resources and aggressive growth stocks.

Finally, the Shepherd Large Cap Growth Fund ( DOIGX) liquidated all its stock holdings and held cash as of mid-September, smartly missing out on this bear market.

10 Best-Rated Stock Mutual Funds
Fund (Ticker) Rating
Total Return 3 Years
Total Return 1 Year
Objective
JPMorgan Market Neutral Fund A (JMNAX) A+
5.37%
1.82%
Equity Income
Arbitrage Fund (The) - Retail (ARBFX) A+
4.18%
1.39%
Growth & Income
JPMorgan Multi-Cap Mrkt Netral A (OGNAX) A+
0.49%
-4.00%
Asset Allocation - Domestic
Virtus Mkt Neutral Fund Class A (EMNAX) A+
-2.24%
-0.58%
Growth - Domestic
Aberdeen Equity Long Short A (MLSAX) A+
0.03%
-11.30%
Growth - Domestic
Calamos Market Neutral Income Fd A (CVSIX) A+
-2.77%
-15.47%
Equity Income
Highbridge Stat Mkt Neutral A (HSKAX) A+
4.70%
4.41%
Equity Income
Permanent Portfolio Fund (PRPFX) A+
1.89%
-18.61%
Asset Allocation - Domestic
American Century Long-Short Eq A (ALIAX) A+
1.00%
-7.01%
Growth - Domestic
Shepherd Large Cap Growth Fund (DOIGX) A+
-2.32%
-9.96%
Growth - Domestic
Source: TheStreet.com Ratings

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 TheStreet.com, 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.

More from Mutual Funds

60 Seconds: What's the Difference Between an ETF and a Mutual Fund?

60 Seconds: What's the Difference Between an ETF and a Mutual Fund?

Mutual Funds on Track for Record Year

Mutual Funds on Track for Record Year

Bitcoin Today: Prices Come Off Highs as Rally to $10,000 Pauses

Bitcoin Today: Prices Come Off Highs as Rally to $10,000 Pauses

Video: How to Select Mutual Funds in Your 401(k)

Video: How to Select Mutual Funds in Your 401(k)

Tax Tip: Uncle Sam Will Be Looking for Your Cryptocurrency Trades

Tax Tip: Uncle Sam Will Be Looking for Your Cryptocurrency Trades