Albert Tsao is a corporate director of investments at Northrop Grumman, where he assists in the management of over $60 billion in retirement assets. He is currently head of public markets, leading the team’s investing efforts on global public equities and fixed income. Upon receiving his MBA from UCLA, Tsao joined Northrop Grumman, worked his way up the ranks, and has been responsible for the public markets portfolio since 2013.
In his current position, Tsao has worked to reimagine the way Northrop Grumman executes public equity strategies, and by doing so has drastically increased the performance of the portfolio by altering the way in which investment managers are hired and incentivized. He has worked to onboard strategies with a high degree of alignment by structuring economics with low management fees and relying primarily on performance fees. Tsao is focused on equity managers with an absolute return orientation, which has resulted in partnering with benchmark-agnostic managers with concentrated portfolios. These philosophical shifts, as well as pioneering the use of hedge-fund long only portfolios and country/regional mandates, have significantly increased the alpha generation of Northrop Grumman’s public equity portfolio.
Tsao earned a ranking in this year’s NextGen by being a thought leader in the public markets arena and transforming his portfolio in a unique and alpha-generative way, thereby helping to fulfill and maintain fund’s fiduciary obligations.
CIO: What did you think you understood before the COVID-19 crisis … and if, during the crisis you were proven wrong, what did you learn from it?
Tsao: The biggest false assumption I had going into this crisis was that I believed Western governments to be skilled and prepared enough to defend their citizens and economies from a viral pandemic like COVID-19. A pandemic of this magnitude has been widely imagined, and not just by science fiction writers. I believed that the West should have prepared, especially considering they had been given a 30–45 day head start by the virus affecting China. If even China concealed facts around the virus, I made the erroneous assumption that the Federal government was prepared. I thought that the pronouncements from elected government officials were mostly bluster and that behind the scenes, they were getting ready for the virus to leap over from China. Unfortunately, I was seriously wrong.
The market reacted exactly the way it should have reacted after it became clear that COVID-19 was an unstoppable pandemic. By that time, the genie was out of the bottle and there was no way to put it back in. I wasn’t surprised at all by the dramatic sell-off from the market. The market reacted exactly the way it should have considering governments around the world essentially shut down their respective economies to stem the pandemic. The speed in which the market sold off also demonstrates that the market was similarly taken by surprise by the pandemic hitting Western shores. Everyone assumed the virus would have been contained. I think there were few market participants that expected the virus to jump from China to the West in the way it did.
CIO: What took you by surprise? What worked?
Tsao: From a market functionality standpoint, the biggest surprise I saw in the market was the illiquidity that off-the-run US Treasuries exhibited. I was surprised that the broker-dealer community did not support Treasury trading. The bid/ask of longer dated Treasuries was simply not appropriate. Broker/dealers got paid way too much to trade Treasuries. US Treasuries need to be able to hold their value during market crises like this in order to give investors the confidence that Treasuries can be liquidated and rotated into risk assets and provide a floor to prices.
From a monetary and fiscal policy perspective, central bank and governments did exactly what they needed to do—provide liquidity and just straight up cash to prevent the pandemic from becoming a depression. The Federal Reserve backstop allowed high-quality companies to access the capital markets and demonstrate to investors that they didn’t have a liquidity problem. Despite the massive sell-off in equity prices, the Federal Reserve programs stopped a self-fulfilling prophecy of corporate insolvencies. On the monetary side, by giving out free, unconstrained stimulus checks and boosting unemployment benefits, the government was able to hold-the-line on the pandemic advancing, essentially paying people to stay home. This bought the economy time to sort through the immediate effects. All these efforts have paid off in the near-term. Certainly there’s a lot of uncertainty as to whether or not there will be a second wave, but at least the first wave was not an unmitigated disaster.
CIO: How would you build the portfolio differently now that you have gone through this massive accelerated shift in the market? (What changes do you plan to implement? What were the biggest challenges?)
Tsao: Hindsight is always 20/20. So, in hindsight, I would not have built our portfolio or positioned our portfolio any differently than what we did going into this crisis. We felt that we had the best portfolio possible going into the crisis. It was a portfolio that was well balanced to handle most environments. I don’t think one can even remotely plan for a pandemic like event—one that truly comes every hundred years. That type of insurance cost is simply too expensive and can be hedged much better—probably just through time and letter assets rebound. One cannot and should not model that certain companies, other than through some massive idiosyncratic event, produces zero revenue over a certain time period like what has happened when the government shut down retail, leisure, and travel.
In terms of changes in the near and immediate term, I think it’s all about relative value between asset classes and investment managers. I don’t think one should be thinking of wholesale investment philosophy changes given COVID-19 because it’s SO outside the normal course of business. I think one stays super diligent on asset prices. There are liquid asset classes that one can move on faster than others and should be taken advantage of. On illiquid opportunities, I think one has to be careful not to spend their dry powder too quickly. One never knows what will be the next shoe to drop and when that will happen.
CIO: ESG has been a tidal wave force behind recent innovative investment framework in our industry. How do you see the ESG framework and effort be influenced by the recent event?
Tsao: I have not been an advocate of ESG as an investment framework. I think it was created by the asset management industry so that people can focus on something rather than nothing since active management continues to do so poorly. Fundamentally, I do not believe that companies who are not focused on ESG can be long-term profitable—their customers, employees, and other stakeholders simply wouldn’t allow for it. Since I’m a bigger believer and advocate of active management, it is up to research analysts and portfolio managers to find companies that are long-term profitable and sustainable rather than just some list of companies that pass an ESG screen. I’m not a prophet or the son of a prophet, but I do not believe ESG is something we’re going to talking about 10–20 years from now.
CIO: What’s your view on the “perfect storm” that is currently impacting the oil markets, and how that will change how you invest in upstream energy?
Tsao: I think this “perfect storm” is absolutely devastating for the oil industry in the near term. This is the difficulty of having an entire industry based on the price of a commodity and all the inputs that go into that. Depending on how long oil prices stay long, the companies with higher break-evens will all need to restructure. They simply don’t have the runway. I don’t think there’s any way that peak demand will come back in the near term. The problem is, restructuring doesn’t help them with their longer-term problems—the viability of lower-cost energy substitutes in the form of industrial scale wind and solar producers. Production cuts will be made in the near-term through the bankruptcy process and longer-term through increased competition from alternative energy. I think upstream energy will be a very difficult space for years to come.
Unless they can figure out significantly lower cost of producing and extracting the oil, I’m not sure if there’s any long-term future for them. In terms of long-term, I’m talking 20–30 years from now. Long before electric vehicles reach a tipping point, oil prices will peak. Not good for the oil industry, but probably pretty good for the climate.
CIO: What’s your view on the fate of the Euro and the EU?
Tsao: This is a tough question. Though I was a political science major as an undergraduate, I certainly do not think I am in position to discuss geopolitics to a fine degree. My absolute layman’s opinion is that the Euro and the EU is going to survive, but is not going to thrive. I just think it’s too optimistic to blend all these nationalities and cultures together, expect them to gel, subsidize each other, and be happy about it. There are reasons why we have individual countries and borders. Those are usually because mankind likes to separate and create division.
Federations and unions like the United States and Canada are uniquely different because their origins were based on immigration and multi-culturalism. Europe’s borders were created by wars. There’s a big difference when one state subsidizes another state in the United States, but I can’t imagine Northern Europe ultimately subsidizing Southern Europe forever. No border control and free tax zones, sure. Massive aid to a struggling country without demanding massive reforms, forget it.
CIO: What do you think will be the impact of COVID-19 on developing economies?
Tsao: I think the impact of COVID-19 on developing economies is going to be massively challenging. They certainly do not have the medical infrastructure to assist everyone who would need care. Nor do they have the ability to shut their economies down indefinitely. I think they will need to learn to live with the virus. Unfortunately, I do not see how developing countries (and of course, not all EM countries are built the same) get through this without a high number of inflections, fatalities, and challenged economies. Hopefully, I’m wrong and by taking basic medical precautions and mandating masks immediate spikes of the infection rates will be dramatically curtailed.
CIO: What are the new creative/innovative strategies that you are researching right now?
Tsao: We are constantly looking for new creative/innovative strategies. I manage the Public Markets portfolio, so I am primarily responsible for liquid strategies. Philosophically, we have been focused on benchmark agnostic, high tracking error strategies for the last few years. The focus on absolute return on the equity side has certainly paid off well for us. So, we’re going to continue to look for investment managers who are managing their portfolios irrespective of the benchmark. This tends to be concentrated portfolios or long only strategies managed by hedge funds. More recently, we’ve been researching individual country strategies, especially in the emerging markets as well as sector funds in the United States and globally.
CIO: With the shakeout of industries currently going on—where do you see the most exciting opportunities over the coming years?
Tsao: There is nothing novel about my next statement whatsoever. I think the emerging companies initially funded and sponsored by venture capital or through internal investments in the technology sector will continue to garner market share from existing old line companies. Or they will create new markets and new demand that didn’t previously exist. The internet will continue to allow the vast economies of scale needed for rapid and massive growth. While there will be plenty of losers, there will be enough winners to allow for investors to participate.
And as usual, it will take astute investment managers to find those diamonds in the rough.
CIO: And professionally, where do you see the most exciting areas to specialize further over the coming years?
Tsao: The evidence is clear that the average asset owner is giving up on active management, certainly in active public equity management. I think that trend will continue. As that trend continues, there will be more room for the surviving cohort of investment managers to deliver significant out-sized excess return. I think it will take more skill to find exceptional investment managers and allocate to them earlier in their lifecycles. I believe partnering with owner/operators will continue to produce fruit over larger asset management complexes.
CIO: How is the quarantine affecting the way you view teams and working environments, such as work from home, meetings, etc.?
Tsao: The quarantine is pretty much over for us. We worked from home for close to two months, but we started to come back to the office. My company is considered an essential industry so we have always been able to come into the office. We used Zoom a lot while we were working from home, but I don’t think Zoom did justice to physical meetings. We are currently not receiving any visitors nor are we traveling anywhere. So, while working from home was disruptive, I think more disruptive in the near and intermediate term is not visiting investment managers to talk through the current market environment and investment opportunities.
CIO: What exercises have you found useful?
Tsao: The most important thing for me is getting out of the house. Anything beyond that is gravy. Personally, I ride my bike early in the morning around the city for my basic exercise. It’s a fantastic way to start the day. I am fortunate to have some young boys that I play baseball and basketball with on most days. Finding the court or field space has become increasingly difficult as the city park system has pretty much closed all the basketball courts. But if one looks hard enough, there are still some courts and fields available.
CIO: Who is the manager you don’t currently work with whose brain you’d most like to pick for an hour?
Tsao: Warren Buffet. Not a very unconventional selection. I think there are a ton of smart younger investors available, but having the broad breath of investment knowledge and historical context would be invaluable.
CIO: And in a fantasy scenario, if money was no obstacle, where in the world would that meeting take place?
Tsao: Of course, Gorat’s Steakhouse in Omaha, Nebraska.
CIO: What asset class or investment troubles you most right now—and why?
Tsao: While this is completely priced in, highly indebted retail and energy companies are not going to survive this pandemic. It almost doesn’t matter when the economy opens up. Certainly, if the economy opens up slowly, these companies will need to restructure. However, their longer-term prospective are in jeopardy as well as e-commerce trends continue.
CIO: Name your four-member investment dream team for your own family office.
Tsao: Warren Buffet, Seth Klarman, David Swenson and Seth Alexander.
CIO: Describe the weirdest interaction you’ve had with an asset manager.
Tsao: Surprisingly, the mass majority of my interactions have been super professional. I’ve certainly met investments managers all over the place. I’ve met people at airports, random coffee shops, and hole-in-the-wall offices. However, I think the most bizarre meeting I have ever had occurred in an old office building in Soho Manhattan. The manager was a young man in his mid-30s. Very well-credentialed. MBA from an Ivy League institution. Tremendous investment track record. While my colleague and I came into the office with our suits and ties, he greeted us in old khaki cargo shorts and a loosely buttoned Hawaiian shirt. His office reminded me of someone’s college apartment. We sat down on the sofa, briefly talked investments, and left after an hour. It was certainly interesting.
CIO: What should be an investment trend, but isn’t (yet)?
Tsao: Pay for performance. True active management. Benchmark agnostic. Negligible to zero management fee similar to passive investing. Performance fee only. The asset management industry is a strange one where vendors receive payment for not meeting objectives. With the advent of passive investing, we do not need investment managers who fail to perform.
