Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. With the equity market rally in its 11th year, many investors may be wondering if the end of that rally could be around the corner. And if it were, how would their portfolios respond? Here with me to talk about some of the best diversifiers for an equity portfolio is Christine Benz, our director of personal finance.

Christine, thanks for joining me today.

Christine Benz: Susan, it's great to be here.

Dziubinski: First, how can we tell if a given investment type offers diversification versus equities?

Benz: Well, there are a number of ways that you could try to get your arms around this. One that we like at Morningstar is a statistic called correlation coefficient. And essentially, that means that we compare two assets' performance to one another. And what we're looking for is a negative correlation coefficient. That would mean if my equities go up, X asset goes down. That's what I want if I'm looking for diversification. If we see two assets that have a correlation coefficient of 1, that means that they tend to move kind of in lockstep, that if one is up, the other is up, too. What we're looking for is that negative correlation.

Dziubinski: Now, these correlations are backward-looking, meaning they're based on past performance of these asset classes. They can't really predict the future, right?

Benz: They can't. Unfortunately, though, they're the best we've got, in terms of trying to figure out what will offer some diversification relative to the equity market. It's the closest thing that we can come to try to predict the future. And we have seen these correlations fall apart at various points in time, but we've also seen them hold up at various other points in time.

Dziubinski: You recently did some research taking a look at the different asset classes to find out which ones offered the best diversification alongside the S&P 500. And Treasury bonds came out looking pretty good on that mark, right?

Benz: They did. And that's been a consistent finding. As long as I've been measuring these correlation coefficients relative to equities, Treasuries have tended to look pretty good. What surprised me in this latest data run, Susan, was that we didn't have to venture into long-term Treasuries to capture good diversification relative to equities. Short- and intermediate-term Treasuries did the job, too. And the reason that's important is because short- and intermediate-term Treasuries are much less volatile than long-term Treasuries. The main reason most investors don't own long-term Treasuries is that they tend to have almost equity-like volatility. Well, the good news is that you don't have to venture into them to get good diversification for your equity portfolio.

Dziubinski: Now, interestingly, if you look at the asset size of various different Morningstar Categories, the Treasury categories actually don't have that many assets. It's more the intermediate-term bond core categories that hold a lot of assets. So, how did those types of funds hold up in your correlations?

Benz: Well, it's interesting and the answer is, it depends. So, within the core intermediate-term bond category, we did find some that were quite good diversifiers. So, lo and behold, a Bloomberg Barclays Aggregate Fund was quite good as a diversifier for an equity portfolio, in part because as currently constituted, these aggregate trackers are very heavily tilted towards U.S. government bonds. Other intermediate-term bond types, especially in the core-plus space, which typically have higher yields, but also venture into some lower-rated securities, those were a little less effective as diversifiers. On the other hand, you are picking up a higher yield on an ongoing basis, which should translate into a higher long-term return. The trade-off though is that you have a little bit less ballast in case of an equity market shock. So, that's something to keep in mind.

Dziubinski: Interesting. So, what other categories were maybe a little bit less impressive?

Benz: Well, probably not surprisingly, when we looked at other equity types alongside the S&P 500, you didn't get a lot of bang for your buck in terms of diversification. So, foreign stocks, for example, somewhat uncorrelated to the U.S. equity market, but nonetheless, not an extremely low correlation. Same with U.S. small-caps, not too impressive there. Also, the alternative asset class' performance wasn't especially attractive there either from a diversification standpoint. Within that space, the one category that stood out in terms of offering decent diversification benefit was--I used SPDR Gold Shares, which owns gold bullion. That actually performed decently well as a diversifier for equity exposure.

Dziubinski: Interesting. This is really great food for thought when you're thinking about how to protect your portfolio. Thanks for your time, Christine.

Benz: Thank you, Susan. Great to be here.

Dziubinski: I'm Susan Dziubinski for Morningstar. Thanks for tuning in.