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

All right, everyone, thank you so much for being here today, and anybody who doesn't know me, I'm Ben Budish, I'm Barclays brokers asset managers and exchanges analyst, and delighted to have us with us today, Thomas Peterffy, who is the Founder and Chairman of Interactive Brokers. Thomas, welcome. Thank you so much for joining today.

Thank you very much. I was worried that not everybody will fit into this room, but it looks like -- I hope more people will come and...

I'm sure they're all...

Yes, right. Okay.

So perhaps maybe just, if you could share maybe your high-level thoughts on kind of the broader trading environment and the macroeconomic environment, and you've been kind of looking at this space for a very long time. How do you see inflation, pricing rates, a potential recession? How might this impact your customers, particularly retail traders who may be more impacted relatively by kind of these macro factors?

Okay. So to me, it looks like inflation is going to moderate on the short term but by no means is it over, I think there are deep long-term dents in the economy that are going to stay with us. The first one, I would think of is deglobalization, over the years over the several decades, we have gotten used to allocating various, the production of different items and services to different nations that we trade with each other due to the high international tensions, I think that is going to be over and so everybody will have to produce whatever they need at home, and that's going to be a long and expensive process. Secondly, we have ESG and not so much from the environment point of view, which is going to be pretty expensive by itself, but also the social aspect, I mean, replicating the distribution of differentiation and gender groups within each organization is going to be a pretty difficult task. We have demographic and education issues as far as skilled labor is concerned and finally, there is the ongoing deficit and the higher debt service due to higher interest rates, which is all going to add to deficits, which is going to add to inflation. I think customers will get used to higher interest rates. Basically, we have lived with higher rates and inflation rate also around 4% to 5% over most of the last century. So I don't think that, that is going to substantially impact the business.

So speaking of kind of the business in particular, I think one of the most interesting things about your company is sort of the account growth story. I think you said long term, you kind of expect account growth of 30% with a very long-term target of $80 million, which is about 1% of the world's population. Can you perhaps talk about your confidence in achieving that goal? And what sort of sustained given that there are some puts and takes quarter-to-quarter, but over the longer period of time, kind of what gives you confidence in this?

So my confidence is very, very high because on the long run, I always get what I aim for, and that's what we're aiming for. So that's there is no, we don't worry about that, right? that it will be 30% some years, it will be higher, some years, it will be lower but that's what we want, and that's what we'll have.

Fair enough. Can you perhaps elaborate a little bit more on the path to achieving that? I think one of the things we've admired about the story is your competitive positioning overseas. Can you speak to that a little bit in terms of how you kind of go about acquiring new customers and what gets you there?

So investing is becoming a global phenomenon. Many financial institutions now realize that they haven't kept up with creating their technology to service the needs of their clients so even if they were to begin building that stuff now, it's going to take them years to get there and so I think it's important for them to be able to service their clients right now and then one of the things that they can do is to come on to our platform, put their clients onto our platform and that's what they are doing and eventually, maybe they will develop their own, but the needs of what to build technologically for all companies are so high now that if they can farm out a certain aspect of what they do reliably, then I don't think that they will do that. So they are just focused their resources and other things and I think that's a good niche for us to be in.

That makes a lot of sense. Maybe more like kind of near term on the same topic, I think you've kind of recently been talking about like a near-term slowdown and as a one introducing broker, I think, is withdrawing customer accounts to their own clearing firm but at the same time, there's a, you have a very solid pipeline of new kind of FIs looking to offer the solution to their own customers. Can you maybe talk about kind of tactically over the next couple of quarters to next year, what that progression sort of looks like?

So we have 2 very large and several midsized and many, many smaller institutions that we're working with. The larger they are, the slower they are because they seem to have difficulty making decisions whether they want to do A or B or C and nobody really is at the point where they are willing to stick their neck cards, so they'd like to keep all their options open. That's very difficult but anyway, I mean, slowly they are slowly coming along and so over the next 2, 3, 4 quarters, we are going to bring all of them onto the platform and in the meantime, several others, I think, will begin to apply.

Wonderful, maybe on the topic of kind of retail trading in general, it seems like the kind of consensus view is that post COVID and especially post all the commission cuts among some of your competitors that it's easier than ever to, for retail traders to be quite active in the stock market. How do you think this kind of plays out over the next couple of years? Do you think things stay elevated? Do you think engagement among retail traders picks back up? Do you see and perhaps your customers maybe tend to be a bit more sophisticated than the average retail trader, but increased adoption of derivatives and other kind of complex trading strategies.

So as long as the global economy continues to rely on publicly owned and traded companies, I think that there'll be there will be more and more people that will be interested in investing as they get used to the products and services that these companies are offering to them, and they will, as users, they will develop views of what they like and what they don't like and what they think is superior to another. So they will be attracted to investing and at least the top 3%, 4%, 5% of the population. I mean in, as far as education financial means are concerned. So I wouldn't worry about that. As I say, as long as the economy is going to rely on publicly traded companies. If we go to social, some that's a different story that you know.

I think if we go there maybe we have a....

Sorry?

I think if we move there we all maybe have a different problem in terms of...

We have to look for other job.

So maybe one last question sort of on the retail account side. I think a lot of your account growth comes from more retail customers joining the platform and as I think you've talked about, they tend to be a little less productive versus your proprietary traders and hedge funds, hedge fund customers that you also have. So they do kind of grow and scale over time and so kind of given the new influx of retail traders over the last couple of years, how do you suggest investors sort of think about your trajectory in terms of client equity growth in trades per customer, on those kinds of factors as we're kind of balancing rapid account growth, but smaller, less productive accounts at first when they joined the platform.

So there is no doubt that hedge funds, proprietary traders and financial advisers and sophisticated investors are basically the cream of the crop for us and they generate substantially much, much more revenue for us than the retail traders, and we do spend a large amount of resources on building the platform for them and it is those people we build a platform for and we just think that if we have built that platform, we may as well accept retail traders and let them figure out how to use the platform, some succeed, most of them don't, but that's okay with us. But on the long term, I think that it should be our goal to educate retail investors about the economy and our stock prices are a result of investors' opinion about the economic costs looking in general and in very specific terms, looking at specific companies and we did take on this major challenge to educate the masses in this respect, and we are going to we are working on products that will come out with in the near and more distant future that will help us doing that and I think that in the long run, our return from that investment is going to be even higher than it is from catering to the sophisticated part of the investor group.

Okay. Great maybe shifting gears a little bit to the regulatory side. So earlier in the year, [indiscernible] sort of laid out some thoughts on potential changes to market structure. What are your thoughts here? What might happen, what are sort of the optimal kind of conditions for the highest quality retail trading? What are the likelihoods of the sort of passing of things like including odd lots and NBBO and adding sub-penny increments and the likes?

So we definitely expect that there will be changes on PIC increments. The one centric increment is way too high for less expensive stocks and possibly too small for very high-priced stocks. So I think that definitely will be room for mostly decreasing and taking increments. It is also, it's an uneven playing field because an institutional client can only send in orders denominated in cents, while people who are on ARPUs or even within exchanges, they can in some circumstances, negotiate sub increments, but not everybody is able to do that. So I think that has to change. I think there'll be some modifications to execution rules and disclosure. I don't think that payment for order flow will be changed because that could create unintended circumstances and it would be too big an area to try to merge all it because we could end up with results that would not be welcome.

I see. So on the topic of order flow payment. So you notably don't take order flow payments with the exception for your right customers and as I've heard you say many times, it's sort of the company's technology that sort of enables you to deliver an all and lower cost of trading versus the free trading that's provided through many platforms that do accept order flow payments. So can you perhaps just talk about the technology behind all this? How are you able to do this? And as I started learning about the company, one of the first things that was sort of interesting was the very intense focus on automation and the sort of the tech stack in general. So if you could speak to that a little bit, that would be wonderful.

So there is nothing that we do that other companies couldn't do. I just don't think that they are focusing on this but they are focused on different areas of the business than we are. So then they build account structures around different retirement plans and for long-term investment of lifetime investments for regular reach people, and that is very useful and profitable thing to do but for us, it's very boring. It's boring stuff It's not interesting. We're all about trying to give our customers an urge in trading and investing with our execution venues, order types and tools in addition to paying 0.5% on their fed fund rates on hydro, but available cash, low margin rates, low stock borrower rates, higher short rebates new venues for execution and so it's all about increasing our customers' urge in the competitive of trading.

What about outside the U.S.? You mentioned there's not much you can do that your competitors couldn't do, they just focused on other areas but I think your international exposure is quite differentiated and I believe part of that is sort of technology driven. So can you perhaps talk about the competitive environment outside the U.S.? I know that I believe the big piece of it is you're able to help those customers trade U.S. stocks, but how do you sort of see competition? Or is it perhaps just a highly fragmented environment and there's just a ton of market share for the taking?

Just like inside the U.S. outside, we compete with the same major global investment banks, but the other large U.S. online brokers are very spottily represented, and that is understandable because there are many different jurisdictions around the world have all their own rules, and it becomes a real pain in the neck to accommodate to them and, but we have taken on ourselves the task of coding all those rules in the different jurisdictions. So we spend a great deal of time and effort to do that over the years and so it is very, very simple for us, except to the extent that these rules also keep changing all the time. So it's difficult, but we are married to that business model. So we will keep at it, and we will be able to service people from most parts of the world.

So again, on the same line, we're talking about your kind of global customers. How does the customer type different geographies? How much of a difference in there is there between what customers need or want in Latin America versus Asia versus Europe? And do you sort of have different strategies in these geographies? Or is it sort of all under the same bucket of low borrower rates, excellent trading tools and the likes?

So for us, there isn't any difference because we believe that no matter what price, what part of the globe you live up our customers all want the same thing. They want to make more and lose less money that just that simple so they all want a broker with a platform that most enables them to do just that. For decades, they have focused on creating capabilities on the platform that enables our customers to maximize their returns and to outcompete customers of other brokers.

That makes sense maybe kind of one last question on sort of your growth in international markets. How much of, it sounds like word of mouth is becoming a real strong driving force. How much are you time are you spending thinking about marketing and acquiring new customers directly versus sort of kind of giving the benefit of broader network effects where people are just awareness is increasing because, "Oh, my neighbor trades with interactive my somebody I know from work. Because it does seem like that's been sort of picking up quite a bit and has been sustaining some pretty high growth this year despite very rapid growth last year.

So there is no doubt that where the mark is our most effective sales tool. It's in addition, of course, to our sales force that is becoming a huge asset, the average longevity of our sales force is about 15 years and this is important because we have developed the platform to have so many diverse capabilities that it takes a very long time to digest it for a newcomer and so these people basically grow with the platform and it takes a very, very long time for somebody who is new to come in and simulate all that and so we have to rely on our sales force, and they are doing better and better every year.

Okay. Great. So one that...

Other than that, we also, of course, have digital marketing and TV advertising that Yes, sure.

One I say one final question, sort of the international business and I know earlier in the year and towards the end of last year, there was a bit more discussion, perhaps because it was newer on just sort of the geopolitical impacts on the business, the War in Eastern Europe, political tangents in China. Can you sort of update us to where we are? Are you still seeing similar headwinds in kind of those areas? And what should we expect maybe in the end of the near term?

So we are very unfavorably impacted by China's crackdown on laissez faire capitalism and of course, also by the Russian invasion of the Ukraine. So trading volumes in these regions which are very, very substantial have decreased by over 30%, both in Asia and, I mean, China and in Europe but so in spite of that, we are still growing but much slower than the other rise would have.

Of course. Okay. Maybe switching over to interest rates. Can you sort of remind investors of what your investing philosophy is here? I think in the past, you said you keep prefer to reinvest in short-term securities. Are there any factors that might encourage you to change this? Or is that sort of that's the approach and you stick with it?

Well, for us, it would be extremely risky to go further out on the yield curve because we pay our larger account holders, half percent under the floating Fed fund rate. So if the Fed were to say lose control of interest rates, we could be slower because if you invest, let's say, 3% and interest rates are suddenly up 15%, and we would have to pay 14.5% to our clients while we're getting 3% on their money we would be finished. So no, we are going to play it very safe and just invest very, very short term.

Fair enough. Makes a lot of sense. With rates rising over the last 6 months to a year, what sort of behavior are you seeing from customers? Are you seeing people moving cash into money market accounts? Are you seeing how are you seeing cash balances change? And what happens perhaps longer term, 12 to 18 months, if inflation persists in equity markets remain challenged in terms of cash allocations versus moving money elsewhere.

So I think they offer better than money market funds because we take all the available cash every day and we pay interest on it, and we pay 1/2% under Fed fund raise, as I said. Now other brokers like money markets because they figure that many customers, and they do this, they become neglectful after a while and just leave money laying around in their accounts and so they don't pay an interest on that, and that adds up to a lot from the point of view of the broker. So I think that our way of doing it is better for the customers and what will happen if interest is go to 10% to 15% we'll just pay 9.5% to 14.5%.

All right. I have a feeling I know the answer to this, but is there any difference in behavior with regard to cash usage and holdings inside the U.S. versus outside? I know you, of course, in other countries, there will be different top-down philosophies or interest rates or what have you, but or do customers behave differently and I think this is investors asked about this because unlike your publicly traded peers in the U.S., you do have this international presence.

Well, we pay relative to the benchmark rate. So you can fund an account with us in one of, I think, 27 currencies and if you have your account in one of those currencies, we just pay relative to that benchmark rate. And, but most people tend to, so first of all, most people trade no matter where they are, they trade the big U.S. stocks. That's what they invest in. They maybe buy 1 or 2 or 3 of their favorite local companies on the local exchange, and that is important for them because that is their core holding, but and we that's why we enable them to do that and then with the rest of their money, they trade the Apples and the test laws and the Amazons of the world and they keep so when we convert their money in U.S. dollars, they keep their money in U.S. dollars and due to the way currencies have been moving over the past several months. I mean, they are making out like bandits relative to their own currency. So that's been working for them.

That makes a lot of sense. Speaking about the, I kind of wanted to ask about the crypto offering. So can you maybe talk about what you're offering right now? Where is the demand coming from? Is it primarily retail traders? Do you see like RIAs that maybe want to offer that sort of solution alongside equity investing and other sorts of products?

So we added crypto to our platform because we didn't want especially IRA customers but also others to have to open a different account at a different firm in order to gain some crypto exposure. We find that IRA is by a small percentage of their customers, they can't put them into cryptos and they just sit on it. So they don't trade an awful lot and so to tell you, frankly, it's somewhat disappointing because we are charging we are the cheapest crypto offering in the sense of commission in the sense of trading it but we don't get a lot of interest. So we'll do maybe the 1 to 2,000 trades a day, that's it and we charge so little that that's up to maybe $1 to $2,000.

Well, perhaps that's a function of the times. I mean, I think had you rolled this offering out 3 years ago, who knows what you would have seen would have it been the interim.

It's okay I'm not crying.

Fair enough. Maybe one last question here and just because of your longevity kind of looking at this and your background as an engineer. What are your kind of higher level thoughts on blockchain technology? Is there a future..

Say that again, what is the higher?

Your higher level thoughts on blockchain technology.

Blockchain technology oh right.

Is there a future..., and this is something that I think when crypto was really hot. Everybody was asking this about payments trading everywhere is what's going to be disrupted? Is there a future state perhaps where stocks trade and settle on blockchains is that perhaps many decades out and too hard to know, but just curious on your thoughts there.

Well, so there is a basic problem that they have to resolve and people who advocate direct dealing sort of dismiss this but I think that the central clearing houses are incredibly important and I don't know once you have a central clearing house, I don't see the huge benefit of the blockchain and if it's a reliable central clearing cost every member is guaranteeing the performance of the clearing house. So I heard this idea of maybe we would have direct dealings but who would trust it. So up until that result, I don't think that will happen. I don't think that there are serious technological barriers in the way, but this definitely has to be resolved before we would join any such system.

Sure. That makes sense. What about some of your other kind of new products that you've rolled out recently or have updated?. I'm thinking about things like global trader, the impact dashboard, your mutual fund marketplace. Can you talk about what's most exciting? Where are you kind of getting the most traction?

So global trader is a very, very simple interface that we built originally for stocks only. We added options and cryptos just relatively recently, and it is still a very simple user interface on your iPhone and it's chugging along the impact dashboard is a way to analyze your portfolio from an ESG perspective, you can specify what environmental or social issues are more or less important to you and to reach your portfolio, and it may be even suggest potential substitutions to increase the rating to make sure that your portfolio is more aligned with your volumes. That's what it's about.

Okay. Maybe on the RIA side, I think there's been some chatter, some thought that as some of your large competitors kind of are going through a merger and with an integration kind of about to happen over the next year. I think there's some thoughts that perhaps there may be RIAs looking to change or looking to add a redundant custodian or something like that. So could you perhaps talk about the RIA, the pipeline? What are those kind of conversations like? And what should we expect over the next year or 2?

So there is definitely a lot of chatting in the IRA community and lower worries about the Ameritrade trad merger. Some we get a number of folks who come to us because they are worried about it and also it appears to us that there's a growing number of IRAs and interesting. It's a funny thing because there are a number of companies in the business of buying IRAs, but they don't really deal with the idea that the person who sells is IRA to one of these aggregators is somebody who is looking to retire pretty soon and once they retire, the accounts are basically are there easily recruited by other IRAs who are independent and keep more of what they make and therefore, are more incentivized to recruit these accounts. So it's, I think these firms can survive as long as they keep buying more and more and more and more, once they stop buying it, I think they'll come to a sad end.

So maybe kind of a little bit of a different topic, we were talking a little bit more about the product mix. Can we speak a little bit about specifically like the trading products? Can you talk about what you're seeing in terms of equities, derivatives, commodities. I think you guys have commented commodity trading tends to be more tied to higher inflation. I think investors are looking at this because it impacts some of the other the cost lines. So can you maybe speak about what are investors doing to kind of manage the macro environment? Which products are you seeing more adoption of more recently?

So I mean, the rates is certainly all growing and lately, certainly, future volume has increased substantially and options volume also as a matter of fact, basically, all the growth there is in the business because stock volumes have been relatively steady. So all the growth there is comes from futures and options and it looks to me like that is going to continue to increase because it's very, very exciting. It's something that I've been in the options business for almost about 40 years and no 43, 44 years yes. So that's a very exciting area, and it's inexhaustible. You can get lost in the various complexities and the opportunity. It's a great thing to do.

Maybe one last question kind of following up there. I think on the last earnings call, there were a lot of questions around kind of the transaction costs associated with higher commodities trading but you guys have always had a very heavy emphasis on automation and I think we've seen broadly over the years that kind of cost of trading come down. So could you maybe talk about like what sort of things you guys are doing to optimize the cost there? And what should we expect over should we expect these costs to kind of continue to come down? Or should they kind of flatten out? How should we be thinking about that?

So how much time do we have?

1 minute and 9 seconds.

Sure. That's not much. So we're working on 2 major areas, One is our ARPU for stock executions where we have in all these retail orders, $2.6 million orders a day, right? So we're trying to convince institutional traders to put in, limit orders that are not urgent that can hang out there we're floating with the neat price and hang on there for a long time. So as we get retail orders, we keep banging it and see if there is an opposite order for that specific stock and they seem to get about EUR 0.80 per share sorry, a 0.8 per share advantage and so that's why, of course, the 2 of them together don't give up any spread to the marketplace, right? And there is no execution cost for us because it all happens in our ARPU. So that's free. So that's one thing that we do. The other thing similar thing that we do on the options side is that we..., whenever we get an options order, we notify and we have currently 26 market makers or liquidity providers, let's call them, who will look at each order and of course, we don't tell them which side we are our customers' or buyer or a seller, but they just give us a quote and they take the highest bid for the buys and the lowest offer for the sales. So as a result, we get a very, very tight quote, and they tell us which exchange they would like to see that order to show up and then they start the auction of that exchange. So it's 2 auctions basically and at the end of the second auction, they internalize the trade.

Got it. Well, Thomas, I'm afraid we're out of time. I'm sure you could have spoken for much, much longer this, so I appreciate you keeping that a little tighter and let me just say again, thank you so much for being here. It was a pleasure.

Thank you very much.