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

Welcome to our next session. I'm Ben Budish, Barclays analyst covering the U.S. brokers, asset managers and exchanges. And with us after this session, we've got Thomas Peterffy, Chairman and Founder, Interactive Brokers. Thomas, welcome. Thanks so much.

Thank you very much for having me.

Maybe just to start out, what are your high-level thoughts on kind of the market environment, what are your sort of general observations on volatility, inflation? How could this evolve as we head into the next presidential election? What are your thoughts there?

So if I have a long-term investor or have a time horizon, let's say, 10 years, I think that I want the most is stability. I want to make sure that I don't lose a lot of money, and I'm willing to give up a substantial upside in order to assure that. So I want stability, I want to put my money in a politically, culturally, fiscally and monetarily stable place. I think the U.S. is going to look less and less stable as they move towards the elections. Inflation, which is part of the stability question, will not come down in my view because of high debt service, deficits, the globalization, oil prices, unions, scarcity of skilled labor and legalized shoplifting. I think some foreign investors will reallocate their U.S. investments elsewhere, and that is not bullish. On the opposite side, we have potentially huge productivity gains coming from AI and inflation in used stock prices will rise so there are both sides of every [indiscernible].

Very interesting. All right. Great. Well, let's spend some time talking about the company then. Maybe starting with account growth, which is really a unique kind of bright spot in your story, especially versus your peers. So I think you said you expect about 10% of the account growth to come from word of mouth, another 10% from sales efforts, and some additional growth on top from introducing brokers. So can you talk a little bit about the basis for this outlook? What sort of drives the word-of-mouth growth? Would -- talk a little bit about the sales kind of process? And what are your expectations for kind of total growth over the longer term?

So I'd like to be a little bit more precise here, 10% is too smooth. I expect 10% to 13% account growth from word of mouth and advertising. And as you know, 7% to 10% from our sales effort. Any additional growth would come from existing accounts, the brokers who give up on building their own technologies and decide the onboard -- decide to onboard their introducing brokers with us. Word of mouth with existing customers, recommending the platform today on contract and the more customers they have, the more recommendations are made. Sales efforts are directed to the institutional and larger professional individual accounts. Our sales team is gradually increasing. Here I also include introducing broker startups. Growth about this, the -- above this 20% may come from onboarding existing broker dealers to give up on continuing building the year technology and the cost for the incompliance arrangements, brokers like these have anywhere from tons to thousands of millions of accounts. That's it from my end.

Very helpful. So I appreciate the incremental precision. So it sounds like perhaps the marketing efforts? Or is it fair to assume that they're showing some signs of producing results? Can you maybe talk a little bit about what you're doing there? What does the strategy look like and kind of beyond the key message of lower customer cost, which we, of course, on earnings calls you talk about all the time, but what else are you kind of messaging out there? And how are the early results?

So we have created -- we're beginning automation. So we automate everything. And we finally automated our advertising. So what happens here is that we automatically gauge the yields from each advertising channel every day, and we automatically increase or decrease the spending in that specific channel. So it has nothing to do with people anymore. And so the only thing that people have left to do is try to identify new additional channels which we then throw into the mix, and we keep measuring it. And if it works out fine, and we start to manage it along with all the already existing channels, and we find that it is for worth on our advertising, we certainly gradually improving the yield continued. So that's very good thing.

Definitely. Great. So maybe let's talk a little bit about retail traders, your kind of typical customer, if there was such a thing, retail activity in general. So maybe at a high level, how do you think the typical BPL trader, as we understand it will evolve? Maybe think about it from a product perspective, how sustainable is the growth in the -- we've seen over the last couple of years, thinking particularly about short-dated options? Are they really derivatives in general, the adoption in retail?

So I take the word retail with a grain of salt, right? As you know, we have thousands of customers with -- I mean not -- we have many customers with thousands of dollars, but we also have quite a few billions of dollars. So I think the evolution of these retail customers will primarily depend on the products and investment tools that the industry offers. We have a great opportunity here because we are geographically so well diversified. Our role must be to inform and educate existing and new customers. Starting with the basics of how the free market economy works, our customers select the winners and losers as customers as -- in the role of customers, employees and investors. So our aim is to create products and research to help them identify the interdependencies among companies and economic and social trends to become more successful invest. We must continuously demonstrate why the best informed investors to Interactive Brokers, which is our advertising bottom line after the [indiscernible].

Got it. Maybe in terms of like the daily activity you're seeing, on the last earnings call, you talked about a trend in your customer base, a very heavy weighting, and I think a magnificent 7 with huge unrealized gains, a lot of which you expect calls to be written against. How long could this trend persist? How do you think about the risks where the market turn downwards more sharply?

So obviously, there are huge unrealized gains in these stocks. And I think people are reluctant to pick them because they don't want to pay taxes on the gain. So a good strategy is to write options against override telcos against these stocks maybe on occasion by worrying about them falling. But I think the overrun majority is writing calls on the stocks. And as these stocks, I think, on the long run are going to grow at least imperative with inflation. So I don't think that these gains will never be realized, and this seems to be a very rewarding strategy that many of our customers have. So I think it will go on indefinitely.

Interesting. And so maybe coming back to my prior question on the use of derivatives, I guess, what are your thoughts on -- what does this mean for Interactive Brokers? I mean more options trading relative to stock trading, is it kind of fair assumption?

So our stock trading has been declining. Our stock trading volume or customers stock trading volume has been declining for quite some time, and that is partly due to our reducing -- we used to have a limit on how much commission we charge was very cheap on all stocks and that we will never exceed 1%. So as a result, many of the people who wanted to trade many stocks would come to us because everybody else we charge them 2%, 3%, 4%, 5%, 6% on earning stocks and we only charge them 1%. So we had a lot of pending stock customers. So the SEC didn't like that, and we started to eliminate that. So as a result -- but this is not the only reason why our stock trading volume has declined. I think it's declined because more and more people have transferred to option. So what happened was that our option trading volume has risen tremendously, although stock trading volume has declined some. And now when you go to futures, everybody is saying, well, look, our futures trading volumes are rising. But that's because people look at the futures exchanges published volumes, and they don't seem to break out futures versus options in the future. So in reality, what has been rising is the options on the futures, not the futures' volume. So Interactive Brokers' customers futures' volume has been declining by single digits versus the last year, but the options on the futures' volume has been rising by more than -- so it's options of both futures and on stocks, people [indiscernible].

Interesting. So do you think it's fair to assume -- or I guess, coming back to the original question around trading to the sort of sustainability around options trading in the retail customer base, is there a lot more room to run there, would you expect that the retail trader who's engaged today is going to be trading more options in the future? Or is it more retail traders will start to adopt options? Is that the right way to think about that?

So their expiration options are incredibly popular and saying, well, how come they so suddenly have such a big deal. But the fact is that we had 0 options 50 years ago and we started actually -- I think it's yes, 50 years ago. We had 4 zero-day expirations a year because we had 4 expirations when we started. Then we went to monthly expiration, so we had 12 zero-day expiration a week. Then we went to weekly expiration. So we had 52 daily expirations a year, then we went to weekly and end of month. So we had over 100 days and now we have 250 zero-day expiration. And I think they are in -- first of all, they are cheap. They are much cheaper than several day long option that you don't have to worry about managing your position because it expires into cash at the end of the day. So it's simple and it's easy, and it's very entertaining for people who want to take positions on the specific stocks on the short term because of expectation of news announcements, it's fantastic too. I know, it's going to continue and it's going to spread all over the world.

That's a great lead into my next question. This trend from a geographic perspective. I think we generally observed options activity as a whole is lower in Europe than it is to U.S., especially like relative to stock trading. You're sort of in a unique position to have a view on what is happening in various geographies. So do you think the rise in options that we saw over the last many years, can that happen elsewhere? And if so, why or why not?

So I am not only in a unique position because of our geographically diverse customer base, but also because as market makers -- we started as market makers in 1977. And we created the first completely automated market making system. And as in the very early '90s, European option changes followed by Asian options exchanges -- electronic exchanges are open. We became members of all these exchanges because we have this automated system that we couldn't greatly use to its full effect within the United States because they were open at [indiscernible] exchanges and the [indiscernible]. So with these automated exchanges, we are able to plug in our computers, and we automatically drove for offers and all the options open to close. And so when I went to all these exchanges and I said "please allow us to do this, and we'll bring you liquidity." They all needed liquidity, so they said, "sure, go ahead" and we started first with the German exchange and then [indiscernible], then it spread from there. And on that time, European and Asian options volume were a lot higher than they are today. So what happened was that we had 30% to 40% of the volume at all these exchanges in the '90s. And the big banks in [indiscernible]. So they went to the exchanges, and they said, "please allow us to consummate all these option rates of stairs, and we will guarantee you that we will put up acute clearing cost and charge with the same fee as we are executing the options on the floor." I mean, on the electronic system. And these stupid exchanges agreed. And what happened was that they widened out the spread so that didn't work for the customers, didn't work for the banks, but they -- within 2 years, they killed all the business because the customers are losing so much money that it didn't make any sense for them to do this anymore. So therefore, today, for the U.S. and Asian business is basically coming to the U.S. option exchanges, and what happens in the U.S. is to -- all the exchanges on -- all the options exchanges on OCC, the clearing house, and therefore, OCC will not accept any rate that did take place on our exchange. And so there is some OCC activity that is still with the banks. And yes, you do an OTC option and they still take it very, very customize, so it looks like it's incomparable. The price -- they made the price is incomparable to the exchange listed up, but the fact is that the bid offer is differential. They imputed -- bid offer differentials are huge, and it's not a good business to trade on.

Interesting. Maybe one last question sort of on the customer behavior side. I'm just thinking about margin balances among your customer base. They've been kind of rising fairly steady, sorry, over the last couple of quarters, and still up nicely. It seems pretty core level. So how do you think this could evolve going forward? Is it fair to assume that margin balances generally rise and fall with markets, or are there any points to understand?

That is exactly what we see. The markets go up, margin balance will increase. When markets go down, margin balances decrease. And this is even after 2 days of a downdraft, margin is going to start dropping and 3 days of upmarket, they start driving. So it's incredibly sensitive and it follows the direction of the market. What I cannot figure out is why it is that other brokers charge. As you know, we charge 0.5% to 1.5% over Fed fund for margin loans. So if you -- they're borrowing more than, I think, $300,000, we're charging you 0.5% over Fed funds. If you're under $300,000 all the way down to a few thousand, we charge as much as 1.5%. But our competitors are charging in some cases as much as 7%. And they still have business, and I don't understand. We only have about $42 billion of margin loan balance at this moment. And Schwab and Ameritrade together still have slightly more than that. And I do not understand, I mean we advertise our heart out of this, and we've been doing for years and years, and they still stay there, and they don't pay -- either they don't pay attention or they don't believe it or I don't know. That's all from my end.

The marketing seems to work.

Hopefully, that [indiscernible].

Actually, I wanted to pivot over, but speaking to the marketing, maybe one of the thing I would have like to ask about is your August account growth, which I think you have -- my understanding is any new interest clients or accounts flowing in yet in those numbers? So that seems like a pretty healthy month. Would you attribute that to the marketing efforts? Or was that sort of a function of how market is performing? What sort of drove the...

It's probably both. So yes, the marketing effort is certainly improving. And yes, many people sort of decided that instead of going down, just [indiscernible], but -- so you're asking...

The particular strength in August, is that related?

Yes. So it had nothing to do with -- yes, it was just regular. It was a stronger month than usual, much stronger, yes.

Maybe pivoting over to interest rates' impact on Interactive Brokers. So you spoke a little bit in our conversation, your expectation that kind of stay higher for longer. You said something like that last year here as well, which -- and that's quite correct. So what is your view, maybe first of all, on how that's impacted trading activity and margin borrowing, it seems like your rates are still quite low, but do you think a higher rate environment can impact margin volume in general? Or obviously, we've seen the opposite, we see overall balance higher than pre-COVID. But what are your thoughts there on how that sort of impact the trading and marketing borrowing?

One would expect that this had accelerating impact, but the surprise is that I haven't seen any result. So the trading behavior basically remains the same, margin borrowing remain the same. We don't see any difference, any change. I don't know you people have a change in your mind about how you view the market in view of the higher interest rates. The market doesn't seem to be paying any attention.

And what about sort of the impact, so like a financial question here, the impact on Interactive Brokers' P&L. Investors are always sort of asking, well, what happens when rates fall. And maybe that happens at some point, perhaps it's farther out, I'm assuming, but there's always a view that such short-term duration risk on your investment portfolio that you'd see a more immediate impact in that sort of environment. So maybe a high-level question. Do you think there will get the people on like the right margin profile in the business you've definitely been investing as your margins have come up, helped by rates, but how do you sort of think about announcing those factors?

So it's great fair to all, we certainly would have reduced the earnings because we have roughly $100 billion of cash balance for our consumers. So we pay currently 4.83% on cash balance for larger balances, for balances over $100,000 of total assets. So the way we do it, we pay 0.5% under Fed funds. Our balance is over -- cash balance is over $10,000 for any account that has assets over $100,000. If your assets in your account only, let's say, $50,000 a day, you half it. If there are $30,000, we pay you 30% as much. If they are $80,000, we pay you 80%. So therefore, our -- and our interest income currently exceeds our every other income source. We have very little other income versus other -- both commissions, right? So we have substantial income from lending stock to people who want to export. And by the way, we also pay interest on short balance. If you short something, and we hold the money is collateral as you work we pay interest on that on the same rate. So yes, interest is more than 50% of our revenue, slightly more. And your question was about...

How you think about like investing to a falling rate plan, is this beneficial to your bottom line? Would you think about...

So as I said earlier, I do not expect the inflation rate to come down substantially. And certainly, it won't be coming 2%, and this is going to stick with the current posture of investing in the short term. Maybe we'll go out a little bit if it's really interest rates could come down. But I think why would I be any better on getting at the market, right? The market is there, it's showing me what they are thinking, right? [indiscernible] I didn't believe the interest rates coming down, but I still don't.

Fair enough. And it's interesting. I think investors versus 3, 4 years ago have definitely appreciate the sort of diverse approach to rate management versus what's happened with small banks, some of your peers, it's how stories kind of change with changes in the thing. Maybe moving back to your customers and kind of thinking about growth again here. So a substantial amount of your customers outside the U.S. So maybe in the context of your overall account growth, we talked about that sort of 20% plus how much would be coming from international accounts? And are there any particular regions that you're targeting, or is that may be particularly appealing for you to enter if you're not there currently?

So our current U.S. customer base is only 20% of our total account holders and it is growing at 40%. So it is -- accordingly, it's going to relatively shrink relative to other customers. And well, we like all of our customers. We have to admit that the wealthier the population of any country, the more profitable the accounts are from that country. And accordingly, the U.S. customers are the most profitable, and they are well over $2,000 per account on the average. On the other hand, other countries, actually India, which is the lowest with $150 per year profit per customer account. And everybody else is in between with the exception of some very tiny, poor countries such as Chad and comparison, I mean where we have less than 100 account. So among all the countries that have more than 1,000 accounts, it's India versus the United States and everybody in between. It's $150, $2,200 and everybody in between.

Great. So it's fair to assume that basically, the correlation between average per capita average income, is it a proxy for...

Correct. That's right. With the exception of maybe China or Hong Kong, they are higher than -- they are pretty good.

Very helpful. On the topic of new customers, maybe we'll spend -- you talk a little bit about the introducing brokers' product business. So you recently, I think, in the past you shared that you've got 2 large partners expecting to onboard this year. Is there any update you can kind of provide to the time line discussed on the last earnings call?

Right. So we have been working on this for over a year, right? The first -- the smaller one of the introducing brokers has started on board just last week. So we actually had 17,000 accounts onboarding, I think it was on the -- yes. So they have a total of 97,000 accounts, of which 52,000 accounts are funded. And of that, they onboarded the first 17,000. The total assets for the 52,000 accounts are $42 billion -- $4.5 billion, of which the 17,000 accounts have $1.5 billion and the total amount of cash for the 52,000 accounts is $260 million. It's not a lot. But this is the smaller of the 2. Now the bad news is that the larger of the 2 is slipping to the first quarter of next year. We are asking IR is slipping well, very large institutions, very many people and everybody say. So everybody has to agree and that is very difficult. So everything takes a long time for them to do.

Understandable. Maybe kind of following up there. The customers of an introducing broker partner previously, they didn't have access to Interactive suite of tools, global trading options. That's why the partner wants to partner -- to join the platform. So when they join, presumably, they're -- immediately less productive users, they're used to trading in the local markets, whatever sort of activity they've been engaging with. So how do you think about the productivity of these accounts over time as they log in the next day and all of a sudden, maybe it's not brand Interactive Brokers, but now they can do all the things that you offer, they can trade U.S. stocks, they can trade global options and whatever else?

So it's not only that they are less productive. It is true that they are less productive, but we also charge them less because what we're doing is that we -- our commissions are tiered. So for the first recharge so much for the first few pages and then less and less and less as the volume per account increases. Now for introducing brokers, we take all of their accounts as though as it was one account, right? And so the brokerage charges are substantially less. And that's why we can say to introducing brokers, you don't have to worry about us competing with you because you can charge exactly the same amount as we charge to each individual account. And you make about 40% of the total charges, right? So that's how it works. Now I agree with you that they know when they come on to a platform, they have all of our tools and all of our research and everything we have, but it depends on how diligent these introducing brokers are about marketing it because we are not in communication with the end client because the introducing broker, once we think that the client is on payer platform. So our platform is widely able to them, and they don't know about Interactive. So it's up to them to market or the facilities that we have.

Maybe talking about some of your other customer types. Can you maybe give us an update on the hedge fund segment? You called this out kind of recently as from your other growth areas. Any recent notable trends? Are you seeing traction with new or smaller hedge funds, larger funds looking to add additional primes? And how do you feel your offering compares to your nearest competitors?

So I'm extremely comfortable in believing that when frequent comes off in the next annual survey will be the fourth largest prime broker in the sense of number of hedge funds. On the other hand, I do admit that our hedge funds are on the smaller end. And that's why it's much easier for us to onboard small hedge funds mostly because the Morgan Stanleys and Goldmans and JPMorgans who have much larger customer base do not want hedge funds under $50 million. So they don't have much of a choice. They can either go to people like Jefferies who charge a lot more, much, much more or they go to BTIT or something like that, or they come to us and our offering this much, much more as far as products and technology is much, much better. And so our job now is to make sure that as these -- the ones that grow these smaller hedge funds that have come to us grow, they do not go to the larger brokers when they get to, say, $100 million. And so we have quite a few who have grown, and they stayed with us at least partially because what we don't do is we don't do some, but we don't do capping through. And our research is not -- we don't have these kinds of meetings to major and founders. So -- but we're working on that.

Interesting. What about on the financial adviser side? Are you seeing any pickup in activity? I think you're sort of an expectation that as some of the largest kind of players in the space have quite recently undergone a very intensive integration that there's going to be a pickup in sort of attrition turnover. Is that something you're seeing there? And maybe can you talk a little bit about that piece at the high level? I think there's a lot of focus on retail trading, hedge fund piece, how do you think about how the financial adviser piece sort of fits in?

So we are continuously working on the financial -- we're continuously expanding the technology that we are offering to financial advisers. The fact is that Schwab and Fidelity are very well and healthy and are very embedded in that space, and it is proving to be difficult for us to get more of these folks, and -- but the new financial advisers, the startups are certainly coming to us. So that's growing, but it's -- I must tell you, it's growing at a lower sellable aggregate than they -- either the individual customers or the row shops or the hedge funds are growing. It's growing at roughly 10% or so. It's not -- we're not very proud of how we have been doing there so far, but we are working on it.

That's encouraging to hear there's traction with, especially the newer upstarts, and it's not like you're lacking for growth anywhere else, I understand. Maybe one last question here before we run out of the time. At one point, you were pursuing the bank license in Hungary, so you could offer margin loans that would be funded with customer funds instead of Interactive's own capital. I understood you later decided not to roll forward with that project in Hungary in particular. Is that something we could see in another EU country somewhere down the line? And could you maybe remind us of what the benefits with the...

You will have to excuse me, but because of what's going on, I will have no comment on this.

No problem. Maybe we'll just pivot one last quick question then. Just on the technology side, you're very well known for having a highly automated platform. As I understand it, your key hiring areas tend to be engineers. What are you investing in? What are you sort of most excited about that's sort of new on the tech side?

Well, we have a number of things on the tech side, namely, we have released our new trader workstation. And we have -- as we have talked about it before, we are continuously upgrading our financial adviser software. We are working in a very concentrated fashion on our IBKR ETS, where we are allowing more sophisticated customers to try to cross their stock rates with our less sophisticated traders or customers and still try to give the -- both of them a better price than they would get on the exchanges. And we are working heavily on the options, and where we are trying to cross again, but the eventual growth has to be picked up on the exchanges because, as I said, for option trades to be cleared, we have to take this [indiscernible].

Well, Thomas, unfortunately, we're out of time, but thank you so much. Really appreciate having you here, had a great conversation.

Thank you very much, everybody.