Portfolio Construction Memo: USD NAV Native Currency Portfolio

Date: January 2026 Portfolio: USD-Denominated Strategy Allocation Analysis Period: 2024-01-01 to 2025-10-31 (504 trading days) Risk-Free Rate: 4.0%

1. Executive Summary

This memo presents the portfolio construction analysis for a three-strategy USD-denominated portfolio comprising mt2x, highwater, and tellurian. All strategies are measured in their native USD currency, providing a direct assessment of absolute dollar returns.

Recommended Allocation: MaxSharpe_CDaR

Portfolio Characteristics

The MaxSharpe_CDaR optimization delivers the highest risk-adjusted returns while incorporating Conditional Drawdown at Risk (CDaR) constraints, resulting in superior drawdown management compared to the unconstrained MaxSharpe portfolio.

2. Correlation Analysis

Correlation Matrix

Key Observations

1. Moderate Diversification Benefit: The pairwise correlations range from 0.06 to 0.29, indicating meaningful diversification potential across the strategy set.

2. Lowest Correlation Pair: highwater/tellurian exhibits the lowest correlation at 0.06, suggesting these strategies capture fundamentally different return drivers.

3. mt2x as Correlation Hub: mt2x shows moderate correlation with both highwater (0.29) and tellurian (0.26), acting as a partial connector between the two more uncorrelated strategies.

4. Portfolio Implication: The correlation structure supports meaningful risk reduction through diversification, though not at the exceptional levels seen in market-neutral arbitrage portfolios. The average pairwise correlation of approximately 0.20 is favorable for a directional strategy portfolio.

3. Optimization Results

Five optimization approaches were evaluated, each with a 50% maximum weight constraint per strategy.

Performance Comparison

Weight Allocations by Objective

Analysis

• MaxSharpe and MaxSharpe_CDaR achieve the highest Sharpe ratios (2.92), with nearly identical allocations. The CDaR variant provides explicit drawdown risk management.
• MinVar achieves the lowest volatility (9.73%) but sacrifices 3.4 percentage points of return.
• MinMDD achieves the shallowest maximum drawdown (-3.20%) but at a significant Sharpe ratio cost.
• highwater hits the 50% cap in both Sharpe-maximizing portfolios, indicating strong standalone risk-adjusted performance.

4. Risk Contribution Analysis

MaxSharpe_CDaR Portfolio Risk Decomposition

Based on the optimal weights and correlation structure:

Risk Budget Observations

1. highwater Dominance: At the 50% cap, highwater contributes the largest share of portfolio risk, justified by its superior standalone Sharpe ratio.

2. mt2x Stabilizer Role: The 32.4% allocation to mt2x provides return enhancement while its moderate correlations with both other strategies contribute to overall portfolio stability.

3. tellurian Diversifier: Despite the smallest allocation, tellurian's low correlation with highwater (0.06) provides meaningful tail risk diversification.

5. Implementation Considerations

Rebalancing

• Frequency: Monthly rebalancing recommended to maintain target weights within +/- 5% tolerance bands.
• Trigger-Based: Consider immediate rebalancing if any strategy weight drifts beyond +/- 10% of target.

Capacity Constraints

• Verify each strategy's capacity can accommodate the allocated capital without material market impact.
• highwater at 50% allocation represents the largest absolute dollar commitment.

Execution

• Coordinate rebalancing across strategies to minimize tracking error.
• Consider staggered execution if strategies have differing liquidity profiles.

Currency Considerations

• This is a native USD portfolio; no FX hedging required.
• Returns are measured in absolute USD terms, directly reflecting P&L.

6. Governance & Limits

Position Limits

Monitoring Requirements

1. Daily: NAV calculation, P&L attribution by strategy
2. Weekly: Weight drift analysis, correlation stability check
3. Monthly: Full rebalancing assessment, performance attribution

Escalation Triggers

Review Cycle

• Quarterly: Full optimization re-run with updated covariance estimates
• Semi-Annual: Strategy inclusion/exclusion review
• Annual: Comprehensive portfolio construction methodology review

7. Recommendation

Primary Recommendation: MaxSharpe_CDaR

Implement the MaxSharpe_CDaR portfolio with the following target allocations:

Rationale

1. Optimal Risk-Adjusted Returns: The 2.92 Sharpe ratio represents the highest achievable risk-adjusted performance given the constraint set.

2. Drawdown Awareness: The CDaR objective explicitly penalizes drawdown risk, providing more robust performance during adverse market conditions.

3. Diversification Efficiency: The allocation exploits the favorable correlation structure, particularly the near-zero correlation between highwater and tellurian.

4. Practical Implementation: All weights are within reasonable bounds for execution and monitoring.

Expected Performance Profile

• Annualized Return: 35.2%
• Annualized Volatility: 10.7%
• Sharpe Ratio: 2.92
• Expected Max Drawdown: -4.1% (historical)
• 95% VaR (monthly): Approximately -2.5%

Key Risks

1. Correlation Instability: The moderate correlations may increase during market stress, reducing diversification benefits.
2. Concentration Risk: highwater at the 50% cap represents significant single-strategy exposure.
3. Model Risk: Forward-looking returns may deviate from historical estimates.

This memo is prepared for investment committee review. All performance figures are based on historical data from the analysis period and do not guarantee future results.