Interactive Brokers Group, Inc. (IBKR) Earnings Call Transcript & Summary

All right. So joining us today, we've got Thomas Peterffy, Chairman of Interactive Brokers. Thomas founded Interactive Brokers in 1977. It was one of the pioneers of the financial services industry and especially in its automation. Thomas, thanks for joining us at the conference for the sixth straight year. And today's presentation will be a fireside chat.

Thank you for having me. It's a pleasure to speak to this huge crowd.

So your business has continued to grow at a much faster rate than a lot of your competitors. It took a nice step function in terms of account growth during the pandemic. And in recent months, if anything, it's gotten even stronger. I think you recently said you expect the business to grow sustainably in the 30% range. What do you attribute Interactive Brokers' success in seeing such a dramatic acceleration in account growth?

We're very good at what we do. And we feel very confident about our strategy. We will keep on driving home our major selling points, which is we keep driving down the spread, the bid-offer spread when we execute our customers' trades by getting in institutional orders to save the other side. Number two, we remain and we will continue to be the lowest -- offering the lowest margin rate, roughly about 1% over Fed funds, to people without having to negotiate and all that, that they have to do with all the other brokers. We continuously display our short availability and the accompanying rates. This is again where a lot of brokers gouge their customers by first charging -- we had a customer the other day who came in and was paying 16% to borrow Tesla. I mean it is -- these people should be in jail, sorry. We lend out our fully paid shares to customers who want us to. We guarantee, obviously, the return, and we share the benefits 50-50. We provide the largest global product base, we hope, that is immediately available online. And we give out the best research and trading tools, and we keep on working at that and keep adding to it. And all these factors are responsible for us having reached 7% market share in U.S. listed stocks and 10% market share in U.S. options in November. So we want to be the platform of choice for the hardest-working, most cost-conscious and most successful investors.

And I guess we've been in just this really euphoric period for retail trading since the pandemic began. I guess pretty much every retail platform has seen much higher volumes and much higher kind of trading frequencies among their customers. What do you make of this trend? Are we at a new normal in terms of retail engagement? Or do you think we'll trend back to where we were in 2019 and prior over time?

So I do not know the answer to that question, but I like what's going on and hope it will continue because it's not only good for us. It's also good for the industry and it's good for the country. Because as people trade more and become aware of how companies are on and what they do for a living, they begin to understand that it is not the evil corporations who run the world, but it is the individual citizens who buy their -- consumer and investment choices are running the corporations. So I hope that the trend will continue.

Got it. And I guess one thing that doesn't always get as much attention is the growth in international accounts. Something like 3/4 of the growth is coming from international, pretty similar to the mix of your accounts. How much of the growth is coming from Interactive Brokers taking share from competitors in these markets versus just the natural expansion of the market over time?

So we take share from our peers, both in the United States and outside. But outside, it is much easier because there is a much lesser established broker-dealer culture and technology that we have to compete with versus the United States. But I would say that more than 50% of the customers who come to us outside of the U.S., this is their first brokerage account. And so 47% of our U.S. clients -- sorry, the average age of our U.S. clients is 47 years old. The average age of our Chinese clients is 42. And the average age of clients from anywhere else in the rest of the world is 39. So it's understandable that as living standards are increasing rapidly in many parts of the world, our job is to educate these people about markets and how to invest in them. And so our goal is to attract the top 1% to 2% of the world's population as measured by financial education and know-how.

I guess you hit on that, the top 1% to 2%. Interactive Brokers often called it a semi-professional trading platform. Your customer metrics suggest you're going after that much more sophisticated customer. Do you foresee a point where Interactive Brokers serves the more buy-and-hold retirement-focused investors?

So our strategy has been the same for over 4 years. Automate, automate, automate. That -- we develop our platform for the most sophisticated of hedge funds, and then we know that anybody else can use it and it's going -- it has to be good enough for them. So we don't really go after the buy-and-hold customer, but we welcome them. If they come to us, we do not charge custodial fees, we do not charge ticket charges. So if they want to come to us, they are welcome. But we -- our target customers are the more sophisticated folks.

And then maybe just to round out the discussion a little bit on the client base. Some of the other parts of your business don't get as much attention. So RIAs, hedge funds, proprietary traders, you really don't see a lot of these customer segments at most of the publicly traded peers. How do you think the value proposition that you bring to these customers kind of resonates? And then how do you think about the growth opportunity across these client segments?

So these clients are very important, too. As I've just said, we basically create the software for the most financially sophisticated clients because, as I said earlier, best execution, the lowest cost -- lowest transaction cost to achieving that is very, very important for us. And many of our lesser -- less knowledgeable clients don't even realize it even though it enhances their return. So these clients, the more professional ones, are obviously are more profitable to us because other than executing the trades, we also lend them money and we lend them stock and they use many other or maybe all the facets of our platform. And so that creates profit for us and it exercises our platform and new leads come up and that we are anxious to get client input about what it is that we could do to keep improving the platform. So we have become known as the go-to prime broker for new hedge funds. As a matter of fact, Preqin, which is one of these publications that keeps track of these things, has listed us as the fastest-growing prime broker for 3 years in a row now for hedge funds with $20 million plus AUM, which is, of course, very small, but that's -- they keep track because that's how I think you have to report to the SEC. Now investment advisers are another very important segment for us. We have created a lot of software for these people, where they can group their accounts in -- dynamically into different groups and allocate, trace to them, so they can run -- where one person can run hundreds or thousands of accounts very easily simultaneously. So that is a facility that many RIAs who come to us really appreciate very much.

And you've mentioned several times about your focus on best execution. Your Smart Order Router is really a unique asset among your brokerage peers, most of which are out everything to market makers. Could you talk about the technology underlying the routing system and just how it benefits IBKR and its customers?

So many of you in the audience may not know that Interactive Brokers has come from a market-making background. We started as market makers in the late 70s. And by middle 80s, we were completely automated market makers. Although in the United States, all the exchanges were still open outcry. But as exchanges started to open automate -- electronic exchanges started to open in Europe and Asia and Australia and Canada, we connected to all of them, and we were pumping in bids and offers over the time in an automated manner. And we consume the trades in an automated manner and updated our prices, et cetera. So obviously, the skeleton of this was our order routing system. So by the early 2000s, we were by far the largest automated market maker in the world, but we also had a little brokerage company growing up on the side because we figured that buying out that brokerage -- this big network that we already have. And then as other folks started to come into the business, they started to buy order flow. And we couldn't reconcile the idea of trading against our own customers that didn't pass the smell test. So we sold the market maker, but we retained the order router. And ever since that time, we have a small group that is continuously working on that order router. As new exchanges come into existence and new trading rules come in, we continuously have to update that order router. But -- so our order router is basically the crown jewel of our platform. Other brokers, they may not even have an order routing system. Or if they have one, it must be very old because they haven't used it in many years. So if the SEC wants to do anything about this, I don't know what they will do. And so more recently, we have started to recruit institutional order flow to come and trade with our retail order flow or semi professional order flow. So we have 2.6 million orders coming in a day that we execute, where we're looking for an opposite side. So we have started to talk to BlackRock and Vanguard and others about taking the other side of these orders. And so far, they are very welcoming, but they move very, very slow.

Makes a lot of sense. Could we talk a little bit about the marketing strategy? I mean IBKR has always had a much smaller marketing budget for a company of your size. And you recently commented you'd be stepping up the marketing investments. I want to get to the ESG product that you recently rolled out here in just a second. But I guess more high level about the marketing strategy, given the customer lifetime values are so high, how much would you be willing to invest in customer acquisition in order to lean into your growth opportunity?

So there is no limit to what we would invest only if we could find a really productive way to do that. We have developed the system that measures the return that we get on each marketing dollar or advertising dollar coming back from a channel. And what we find is that as we increase the spending, we very soon reach a limit where additional dollar spend becomes counterproductive because what happens is that as you spend more, you don't only increase the cost of the next account, but you will increase the cost of all the accounts coming from that channel. So you're paying a lot more for the accounts that you previously had gotten much cheaper when you were only getting a few. So it is a very difficult situation. And the conclusion is that you, of course, have to have -- instead of increasing the spending in channels that you have, you have to keep on working on getting new channels. But there aren't too many of them that are -- where the spending is very productive. So it's a difficult situation, but I think we have found a way that works for us and -- but I'm not going to tell you the details.

So I guess you highlighted on the earnings call there was one upcoming product you were looking forward to accelerating marketing on the ESG IMPACT product. Could you talk a little bit more about the product and where you're seeing the demand from your customer base?

So we're very proud of this new product that we call the IMPACT app. It's -- you can find it on -- in the App Store and download it in 30 seconds. It's called IBKR IMPACT. And if you have an account, you can trade in it instantaneously. If you don't, it's not too complicated to open and fund one. The idea behind the app is that it prompts you to signify your values as far as environmental and social issues are concerned, and the app will help you pick stocks that are confirmative with your specific values and rate your holdings accordingly. If you don't like your ratings, it will suggest substitutions for you. And it also accepts charitable donations, and we are now connected to over 30,000 charities that you can donate to.

That sounds exciting. I remember 3 years ago in 2018, the first time I hosted you at the conference, you talked for the first time about a slowdown in account acquisition out of Asia and some of the capital controls that China had put up at the time. More recently, I think you talked about 2 of your introducing broker clients, Tiger and Futu and some of the data privacy laws that have gone into effect in China. Can you maybe just give us the state of the union in Asia? What are some of the challenges and opportunities that you're kind of facing out of Mainland China?

So about 1.5 years ago, our account growth was extremely high in China, and then it suddenly came to a stop. So that at that time, we had about 20% of our accounts in China. So if you do a little math, you realize that if you have your 20% of your return some place and say your growth rate is 50% and that 20% plummets to 0%, then your entire growth will go down by 20% to basically 40% from 50%. So whatever the percentage of your accounts are in any channel that suddenly goes to 0%, that's the same percentage by which your growth rate will shrink. Well, luckily enough, we were over the top segment. 1.5 years, we were able to replace those channels by other countries in the neighborhood and also in the rest of the world. So -- but the fact is that the growth from China is still not.

Got it. Makes sense. And I guess it's a natural segue to talk about the introducing brokerage business. In general, there's been a lot of innovation in fintech over the past several years. So companies like SoFi and Square are offering stock trading services to their customers using an introducing broker model. How is Interactive Brokers positioned to serve the fintech space? And would you consider doing that through an introducing broker model? Would you consider other partnerships?

Well, we do have. We do have the introducing broker model, and then we are actively marketing it. But it basically depends on when you're talking about these folks who are adding stock trading to their general payment and offering. The question is how sophisticated a platform they want. Robinhood has succeeded in convincing the world that a very simple platform with 0 commissions is the recipe for a great business. And that -- maybe I will not argue with that because, as I said, I'm very happy with efforts that bring more folks into the investing area because the more people learn about and get involved in investing, the more stable our society will become, I think. But also, it is a fact that we get a steady stream of accounts from, for example, Robinhood. And while their average account size is about $40,000, the people that come to us have an average size of $75,000, which for us is still small, but for Robinhood, it is supposedly very large. So if you want to add brokerage to your platform and -- you may as well pick Interactive Brokers. Otherwise, if you pick a simpler introducing broker, then some of your more valuable clients who become wealthier want a more sophisticated platform, they will leave you and they come to us anyway.

So I guess this year has been a bit of a wild ride for crypto. Crypto prices seem to be ending the year towards the highs. You rolled out crypto trading over the summer with some very attractive pricing. What do you think about the crypto space? And how do you see the crypto opportunity for Interactive Brokers?

So just like anyone else who is not convinced about crypto, I'm very confused. Because on the one hand, if the government cannot control certain illicit activities that use crypto as their vehicle, they may completely shut it down, in which case it will become worthless. On the other hand, there is a very small chance that the U.S. dollar will become worse. So I have a very small portion of my net worth in crypto. And if anybody else wants to do that or your registered investment adviser wants to do that, tell them that at this time, Interactive Brokers is the only place where you can run an integrated securities portfolio that contains crypto.

Got it. And I guess you've been pretty outspoken for a long time in the bet around payment for order flow. What do you think the SEC is focused on payment for order flow right now? And what do you see as the most likely outcomes?

Well, I think the most likely outcome will be more disclosure because they can't -- in the way I see it, they can ban payment for order flow because the same mechanism happens all the time and has happened for 200 years with large brokerage firms. Or the big investment banks who have a sales department -- a trading department, the sales department gets their accounts and sends the orders to their trading department. But since they are all one firm, the payment is not disclosed in the financial statements or maybe there isn't even an actual payment. But nevertheless, it's the same model. So if they were to ban crypto, I think that the big market makers will all try to buy some of the brokers and become just like all the other investment banks. So if I'm right and the conclusion is more disclosure, that will benefit us because we finally could compare our execution as to that of other brokers.

I guess one notable trend over the past few years has been the decline in your order execution costs, and your execution in clearing fees have been declining as a percentage of commissions over time. Could you talk a little bit about what's enabled you to achieve that improvement?

So well, it's 2 things. One, as I mentioned, we get institutional orders against which we cross our retail orders. We do that in our dark pool and there is no exchange cost. Second, exchanges are now paying instead of charging. There is basically a war for -- among exchanges for market share. So the exchange fees are going away it seems.

Got it. That makes sense. I guess one question on just options trading in general. Retail options trading has been incredibly strong since the start of the pandemic and has been continuing pretty strongly this year. Do you think retail investors are cognizant enough of the risks of trading options? And I guess maybe talk a little bit about what Interactive is doing on the investor education front.

Well, yes, I do think that they are cognizant of the risks and especially -- I mean, I don't know, but I know that our customers are cognizant on the risk. And we actually give you a test when you want to trade options in our platform before we allow you to. And we have a large number of various educational materials and videos, et cetera, that help you in understanding how options work. Also, the large -- the large rise in options volumes, that is all about the war for market share among the exchanges because there is an exchange now that pays $0.80 for a contract if you write your orders to them. Now we have some clients that go for cheap options, which are $0.10 commission per contract. The exchange pays you $0.80. So there are some clients here who are trading very cheap options that basically don't move the price back and forth and back and forth, and they pay us $0.10 and the exchange pays them the $0.80 and we pass that on to them. It's a fun game.

Good business. The company has invested a lot in compliance and risk management over the past couple of years. Could you bring us up to speed on the investments that you've made in your BSA and AML platforms and maybe what the headcount trends have looked like more recently?

Yes. So compliance is a difficult task because there is not a set of written rules that tell you exactly what you have to do. So what you have to do is you have to hire consultants who sort of figure out what you in your specific situation should do. And so we have to write an awful lot of programs and have to hire an awful lot of people. We hired some 300 people into compliance over the last 2 years. And we have a lot of software for them, and that's what we do. On the long run, I guess, that becomes a competitive advantage because it becomes a barrier for smaller firms to come into the business.

Right. Makes sense. Maybe just one question about the stock itself. I mean IBKR still has a relatively low float relative to the overall size of the company. I think most people are aware you have a 10b-5 program to reduce your holdings over a very long time frame. What does the path towards a higher float look like over time? And are there any options that you would consider to accelerate that path?

So Will, I really don't want to accelerate. For -- at this rate, I'd be out of the stock in 60 years. And for one thing, I cannot imagine a better investment for me at least than Interactive Brokers. And if people see that the Founder and Chairman keeps all his money in Interactive Brokers, maybe they will do, too.

I guess one last question before we run out of time. You run a really extremely profitable business. The company has no debt, very high margins. You've been pretty consistent in the past that you're not interested in repurchasing shares. Could you just talk about the capital allocation strategy and how you think about putting some of the capital to work that the business generates?

So we currently have over $10 billion of capital, but the large prime brokers have a lot more. And even though we do not take counterparty credit risk and as long as I have all my money in the company, we never will. But the capital is important for us because we have, right now, I think 11 offices that are independent, that are wholly owned subsidiaries around the world in different jurisdictions. And they each have their own capital requirements. And as we expand around the world, we are looking at having more and more of them and so capital is important for us from that point of view. So as we earn it, we deploy it, and that will go on for probably the next $10 billion.

Makes a lot of sense. Well, Thomas, we're out of time. I really appreciate you joining us today. It's been great as always speaking with you.

Thank you very much. It's a real pleasure.