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

Good morning, everybody. So really excited for our next session with a man who really needs no introduction, Thomas Peterffy, Founder and Chairman of Interactive Brokers. Thomas is one of the first individuals to utilize computerized models and options pricing, really a pioneer in automated equity options and futures market making. Interactive, it's -- they're global leader amongst the technology-driven brokers. They have best-in-class KPIs, which many in this room are keenly aware of. But it's really a durable business model with a strong track record of success. So could not be more excited to have you here, Thomas. And just for those newer to the Interactive's story, maybe just give a quick overview of Interactive, where you fit within both the retail and institutional ecosystem, and how is your value prop differentiated relative to some of the other peers in the space?

Thank you very much for having me here. It's my first time with you. And so about the company, IBKR is very different than other participants in the electronic brokerage space. This is due to the unique way we came to where we are today. I started this business as a market maker in options on the floor of the American Stock Exchange, 45 years ago. Having been a computer programmer before, I was always looking for ways to make the trading process more efficient with the use of computers. 10 years after having started the business, we were the largest fully automated market makers in the options world. As electronic exchanges came to fore around the globe, we connected to all of them. And when the U.S. exchanges finally went electronic, around 2000 was the first one, the ISE and the other is rapidly followed. So after all the exchanges converted to computerized operation, we had a huge global market making system with nearly 20% of the global options volume. Of course, in those days, the global options volume was a fraction of what it is today. So in 1993, we added brokerage capability to our global market making network, which means that for market-making purposes, we are connected to all the electronic exchanges around the world. So we said, well, why not at brokerage? Of course, we were not really smart about thinking about what the SEC is going to say about us being a market maker and the broker, but we kept the 2 things completely different except we use the same communication venues and all the memberships or all the exchanges around the world, thinking that the global demand -- the demand for a global broker will be great, but it wasn't, it still is [ pretty weak ]. So market makers came into the -- came in and started buying retail order flow like YourBoss, and we had to make a choice. We had to start trading -- we had to decide whether to trade against our own orders or not to. So we thought the conflict would be too hard to explain, and we decided not to do it. So we closed down the market maker. And today, we are a pure brokerage with the distinction that we know all about the math and the plumbing on which markets run and still use many of the same systems we developed for the market maker. But we are using them now for our -- on our customers' behalf. So that's basically the short story.

And it's pretty clear, Thomas, based on your remarks that digital technology, clearly embedded in the DNA of the company, how does your tech stack compare with the competition? What are some of the capabilities in your mind that are most differentiated?

So as I said, I was a computer programmer and then everybody I hired were computer programmers. So basically, still today, the leadership -- all the senior positions in the company are basically computer programmers or at least the background they come through. And we always viewed ourselves as a software developer focusing on developing applications for trading and brokerage. While our competitors usually come from a sales background. We are strong on tech and relatively weak on sales, I'm embarrassed to admit it, but it is the fact. From the beginning, it was our plan to build a platform for the most demanding institutional customers and make it available for everyone who wants to use it since it's automated, the additional cost for an additional customer is negligible. So it costs us very little to have additional folks and that what explains our profit margin of 68%, which is pretty high.

And so as we think about the strength of those margins, and just maybe the competitive landscape and the barriers to entry, you've seen really unparalleled account growth, client growth across the platform. It begs the question, why haven't other competitors stepped in, in a more meaningful way to try to replicate what you've built?

Because they are salesman. So the new competitors did emerge along the way, but I think they are too impatient and want to get rich quickly. So as soon as they get to a profitable operation, they sell themselves to the dominant players too soon to have developed the unique platform. I do not expect big changes in this business going forward other than the idea that everybody with a banking or money transmitter license now wants to become broker. But going after the low-hanging fruit, they want to get the simple retail accounts and provide only vanilla services. We are just as busy coding as we have always been, but we are now focusing more and more an out-of-the-way corners of the market and developing specialized tools for different type of customers. This and our much lower cost structure is what makes -- what sets us apart. We keep on building the most versatile and sophisticated platform for the most discerning clients. But since it is all automated, we can make it available to everybody free of charge. So we have no platform fees. If you just want to open an account, put in some money, it doesn't cost you anything. Except we charge commissions. Trading isn't really free. Surprise.

Well said. The other big differentiator, and you touched on this a little bit, Thomas, is your international footprint. We've been following the broker space for a considerable time. Many have tried and failed to really expand internationally. What's contributed to the -- your success expanding abroad? And what are some of the newer geographies that you might look to expand into from here?

So again, the answer is automation. Different jurisdictions around the world promulgate very special rules and regulations. This drives most brokers crazy because everybody really is trying to do the same thing. Our lives would be a heck of a lot simpler if -- and our customers' expenses would be much, much lower if regulatory requirements are the same all over the world. But no, regulators want power and so they introduce their special wrinkles in the rules so that the order-taking, execution, clearing, settlement and reporting compliance and tax functions and the rules governing them are all slightly different from place to place. Since we have this all automated, it's not so difficult for us to tinker with the rules and to modify our programs for each different jurisdiction to comply with those special wrinkles. While our peers when they want to set up for a different jurisdiction, they have to build a different team who really understands the rules there and then supervising them is not so easy because, of course, the supervisors don't know what the difference in the rules are. So that's the reason.

That's great, Thomas. And I'm keen to unpack the sources of growth, but before then, I just want to take a step back and maybe just talk about the operating environment. Certainly a challenging macro backdrop for many of your clients. How is that impacting activity levels? And given your unique footprint globally, maybe if you can provide some perspective on what you're seeing in the U.S. versus abroad?

So these differences, for us nothing much has changed a lot. We just lying ahead, developing our platform further as our momentum slowly increases. When we have a relatively large accumulation of new accounts, in a geography where we are servicing accounts, but we are not physically present. We are not registered there, we get these accounts via the Internet. So -- but then in order to really grow in that geography, we have to offer the local market. And so then we go there and we either become members of the local exchange or we do it through a corresponding relationship. We develop our interface to it at the currency to our repertoire that is currently 24 currencies. In other words, you can open account with us in one of 24 currencies and trade in every other currency seamlessly. So such developments are taking place right now in some smaller Far Eastern jurisdictions and to some extent, in the Middle East.

As we think about the sources of organic growth and account growth, you cited a 30% account growth target. I mean, for context, that's many multiples above, I would say, even what some of your peers aspire to and I was hoping you could speak to what are the building blocks supporting that 30% growth rate in the context of the TAM, different markets, deepening client penetration? Any context would be really helpful.

So a natural account growth of 10% to 20% that comes to us via word of mouth when the markets go down, that natural growth is closer to 10%. When it goes up, it's closer to 20%. Now to this, we add our sales force that generates new accounts, and that's about the other 10%. But it's a very, very lumpy growth. So it's really hard to -- I mean it's easy to project it way forward because it's about another 10%. But nearby, it can be very, very low or very, very high because when a new, say, introducing broker comes in, it can suddenly be a huge account growth suddenly and then after all the accounts came on to us, it slows down to a trickle, and then we have to get the next one. And so that's how it works. We believe that under the platform that brings investors and marketplaces together, all over the world, all over the globe, we will have to -- we will optimize the allocation of capital and resources, and it is our job to develop the best tools and capabilities to facilitate that.

And one of the benefits that you've touted about your diversified model and your diversified client base, you can pivot, so to speak to where the puck is heading. And you noted that you're currently focusing on customer acquisition efforts within the hedge fund channel, a little bit less sensitive to some of the market volatility admittedly. Now how do you see over the long term, Thomas, your client mix evolving over time, just given some of the real momentum that you've seen on the institutional side in particular?

Yes. Well, so first, to address the overall population, we believe that 1% to 2% of the population globally is sophisticated financially and has the where we told to have a brokerage account. So we aim at getting 1%, which should be 80 million people, and we hope to get there in the next 15 to 20 years. And we will -- at the rate of 30%, we will get there. Now as far as institutional accounts, hedge funds, of course, are very important because the 1 hedge fund makes up for -- it's equal in revenues to maybe specifically exactly 67 regular retail accounts. But that's a small hedge fund. The large hedge fund is equal to hundreds or maybe even thousands of retail accounts. So.

And one of the big drivers, enabling you to sustain that 30% growth rate, even in this challenging market, are your relationships on the introducing broker side. I know you alluded to wins. I think there are 2 larger institutions that you're partnered with or have partnered with quite recently. How do these client accounts compare to the typical account that's on the IBKR platform? And how is the pipeline building? Are there any metrics that you can cite supporting the sustained growth within that channel?

Yes. So Preqin, they have -- they usually measure the penetration of different brokers in the hedge fund space and for the third year in a row, we have added more accounts. I don't know if we added more accounts, but our rate of growth has been higher for 3 years in a row than that of any other prime broker. And so that brought us today to the sixth place and fifth place is Credit Suisse, and I'm really sorry to say that they probably will not be a fifth place next year. And the next one is Bank of America, and I don't think they really care enough about this business. So I think that we will be #4 in this current year or the following the year.

It's a space where I think people who cited the fact that you are the #6 prime broker globally in terms of the number of funds that you service. As we think about the gap between #6 and #4, I mean, I know you conveyed it modestly, Thomas, it's a fairly wide gap between you and Bank of America and not unachievable, but...

It's not that wide. I think the difference is 300 accounts, 300 hedge funds.

Okay. It's -- fair enough. I guess like, from my perspective, as I think about the gaps and what precludes you from maybe continuing to gain share, and these are things that you've cited as well, it's the absence of OTC trading capabilities, not have...

Right, right. So there are a number of things that we do not offer. And maybe the biggest amongst them is that we do not offer OTC products. So -- but that cuts 2 ways. The reason we do not offer OTC products is because we do not want to get into the counter-party exposure issue because we have lived through '87, and we have lived through 2008. And I said to myself that after all, it's my money, I'm not going to risk it on that. And therefore, I think when the next crisis comes, some hedge funds, we will think where [ I better ] Interactive Brokers has $11 billion of equity and no counter-party exposure. So if the situation becomes kind of hard to see where the -- where all the dead bodies are buried, then maybe we should have some of our assets with Interactive Brokers instead of Goldman or Morgan Stanley, right? So I think that's an important consideration. Other things, the other services is basically these kinds of meetings, analysts. And that we don't do at the moment, but we may consider either building our own capabilities or get into some sort of joint venture. And what is the other one? It's -- you remember this TV ad that the guy comes up and he says, we have these 3 things: #1, #2, and he doesn't remember the #3. That's just what happened to me.

Cap intro?

Cap intro, right. We don't do cap intro. That's not really true. So we have Interactive Brokers marketplace where we display our hedge funds who want to be displayed, and we display their performance, and we display whatever information they want to provide us to display. And so our accounts or anybody else can come on to our platform and look through and look at their performance. And if they want to contact them, they can. But we do not really get them into a room together with the hedge funds.

Well, that's actually a great segue just for -- we've had a number of the RIAs also present at the conference, after all this a Wealth Symposium. Maybe you can speak to your RIA marketplace offering, how is the value prop differentiated there as well? And one topic that's come up is the Schwab Ameritrade clearing conversion, maybe driving some displacement and an opportunity to take market share?

Yes. So Again, it comes from the automation. So we are much less expensive. First of all, RIAs are the big firms basically get to keep on the average about half of what they produce. With us, they get to keep 100% of what they produce. If independent IRAs come on to our platform, we do not take anything from them. And we have no platform charges. We have no custodial fees. The -- our commission is smaller than what I venture to guess them what their customers have to give up to the market makers when the orders get sold to market makers. And so they can -- to the extent that they are more nimble advisers and they maybe sell short. We have our short availability displayed online all the time. How many shares we have and what it would cost to borrow and you can borrow it online, you don't have to call us. Other firms like it when they -- when the clients have to call them because they basically know from client to client, how much they can really charge because when it's a big client who is very knowledgeable, they charge very little, when it's a small client who maybe it's their first or second time of ever trying to do a short sale, they charge them 5x or 6x as much as they really should. But -- so we don't do any of that. And partly, we don't do it because we don't spend the amount of money that it would take to have that sort of personnel and partly we believe that on the long run, the better break we give to our customers, the more likely they are to be profitable, and we like accounts growing with us. So that's important.

That's a great perspective. The other piece I wanted to unpack is around the account economics. You alluded earlier to the hedge fund multiplier of 67x relative to your traditional retail client. It might be helpful just to give some perspective on the economics, how they differ across the hedge fund client versus active trader versus traditional retail?

So for us, this is only for us. The hedge fund, as I said before, the average hedge fund on our platform, and there are many accounts that call themselves hedge funds, but they are less than $1 million in the account. So overall, our average hedge fund has $5 million. But that includes some very large ones and some very tiny ones. But on the average, an average hedge fund account is worth 67 retail accounts and the average proprietary trading account is worth 10 retail accounts. So that's roughly the comparison and a retail account is -- an introducing broker account is very roughly 0.7 retail accounts. I mean, individual accounts. I don't like this word retail because many of the people who have individual accounts have many millions of dollars and they trade very often. And they are really serious professionals. They are basically the core constituency that we started with, the people who were my friends on the floor when I was a market maker, they were market makers and some of them are still alive. And they are still trading. And some -- so some younger people came along with, generally maybe their children or younger brothers or cousins who took over for them, and they are still basically professional traders.

I wish someone had passed down those capabilities to myself. But well, the other piece I wanted to touch on is just the margin loan opportunity. You've had tremendous success growing the margin book. Given the robust account growth, the 30% bogey that you've cited, is it reasonable for us to underwrite comparable growth in margin balances, assuming or underwriting a more normalized backdrop? I believe your margin balances have grown at a 20% CAGR over the last 3 years. How should we think about the growth in margin relative to that growth in accounts?

So we -- our margin rates are 0.5% to 1.5% above Fed fund rates. And they are -- you know we float with Fed funds. And that when Fed funds rates were near 0, then of course, our highest margin rate was 1.5%, while Schwab and Ameritrade and Fidelity were at 4%, 5%, 6%. So as the Fed fund rates are not rising. So currently, we are at what, 3% and 3.25%. So a 5.25% is our highest margin rate and 4.25% is our lowest. But that is still roughly half of what other folks charge. So we could charge higher, but -- and we are often asked about that why we charge so low if we could charge higher and it will still be the best deal. And the answer is that we have to provide a really compelling deal for people to bring people over from other brokers because people really are very -- they don't like to move. So it's a very sticky business. Once you get an account, you keep that account and you really, really have to screw up and make the account angry to -- for them to change. So these low margin rates are basically the way to try to get new accounts. Now as when the market goes down, of course, much of the leverage comes out of the market. And so in the last 6 months, our margin loans have actually decreased by about 15%. The total margin loans went from $44 billion to maybe $40 billion.

One of the helpful offsets is certainly higher rates. And while you're certainly more generous than most in that regard, Thomas, it might be helpful just to provide some perspective on the overall rate sensitivity of Interactive Brokers?

So as far as interest on cash, idle cash, we pay 0.5% under Fed funds to clients who have more than $100,000 of volume in their account and more than $10,000 of cash. In the -- on the first $10,000, we pay nothing. If people have, say, $50,000 we pay them half of Fed funds minus 50. If they have $80,000, we pay them 80% of Fed funds minus 50. If they have $100,000 or more, we pay them half Fed funds minus 50 other than on the first $10,000, where we pay 0. Well, that's much, much, much better than everybody else pays. It's better than any bank pays because it's -- as soon as you get the next dollar in your account immediately you get interest on that and other brokers like it to sweep your account into money market funds, but then you have to, of course, before you would use the money, you have to be withdraw it from the money market account. And so eventually, you grow tired of withdrawing and putting it back and withdrawing. And so we basically leave your money idle in your account and you get very little interest.

That's great. I mean, I honestly wish we could be chatting even more, Thomas. I have a long list of questions here, but I'm going to have to limit it to just 1 remaining 1 given our time constraints. I really wanted to get your perspective on business threats. We had talked earlier about the strength of your pretax margins north of 60%, at 68% to be more precise. What do you see as the greatest threats to the IBKR model, whether it's like fintech disintermediation from new entrants, increasing technology or regulatory burden, you look like you're not losing sleep over anything. You look well rested, but any perspective you can share?

I was up much in the elections until [indiscernible].

You and me both, sadly.

So to tell you, frankly, I think it's clear sailing. I don't see anything. I mean, I generally worry about systemic issues. But as I said before, given our situation that we have no counter-party credit risk, and our equity keeps growing because we retain all of our earnings, except for the [indiscernible] dividend we pay. And so now we have $11 billion. So I think we -- some people may think -- I certainly think that Interactive Brokers is the safest broker to be with. And even in a crisis, the thing that does worry me is the grid, the electronic grid, if that goes down, we are in big trouble.

Great. Well, a great way to end it. Thomas, thanks so much for being here. Really appreciate it. It was a real pleasure.

Thank you very much for having me and for listening today. Thank you.