Bright Futures Up-and-coming fund makes market inefficiencies work for you.

If you took a finance class in business school or college, yourprofessor probably drilled into your head the "efficientmarkets" theory, which says that it's nearly impossiblefor an investor to beat the market in the long run. Well, businessprofessors, take note: There is one mutual fund that's almostcertain to prove those theorists wrong--Smith Breeden EquityPlus.

How does the fund do it? Its strategy is complicated, but in anutshell, it takes advantage of market inefficiencies. The fundbuys futures contracts that mimic the performance of the Standard& Poor (S&P) 500, an index of the 500 largest U.S.companies' stocks. The advantage of buying futures contractsrather than the individual stocks in the index is that futuresdon't require the buyer to pay the full amount owed until threemonths after the purchase date. This means a buyer has three monthsto invest that money elsewhere.

When sellers price futures contracts, they assume buyers willput their money in three-month Treasury bills. This is where theinefficiency arises. Smith Breeden doesn't invest its money inthree-month Treasuries but rather in longer-term mortgage-backedbonds. Such bonds almost always pay a higher interest rate thanthree-month Treasuries. The difference in interest rates is whatthe fund earns in addition to the index's return. For example,if the index goes up 15 percent one year and the difference betweenthree-month rates and longer-term mortgage rates is 3 percent, thenthe fund will gain 18 percent. When 1 percent in expenses issubtracted, the fund's 17 percent gain still beats theindex's 15 percent return.