Really pleased to introduce our next speaker, Thomas Pederfee, Founder and Chairman of Interactive Brokers. Thomas has a really storied history within the equities and brokerage business, One of the first individuals to utilize computer models and options pricing, a pioneer in automating equity options and futures market making. And his firm is a global leader amongst all the technology driven brokers. And while it certainly has an impressive background, you know, ultimately, when we look at the financials, it's really standout, best in class margins, best account growth across the space, and a really diverse tech stack. So Interactive has, really emerged as the premier player within the brokerage space.
So couldn't be happier to have you here with us, Thomas. Now before maybe delving into your business, you always have interesting perspective on the macro. I was hoping to get your thoughts on interest rate backdrop, expectations around the stickiness of the higher for longer rates, and anything you'd like to share just on how that's gonna impact the financial services and brokerage industry more broadly.
So I'm not saying anything new when I tell you that interest rates go with inflation. Right? And so as long as inflation stays up there, interest rates will go up will stay up there. So I doubt that interest rates will dig below 4% because I think that inflation is driven by the three d's, which is deglobalization number one over the past three or four decades due to the the containerization and the Internet. The the production production of goods and services was reallocated over the globe to places where it's the cheapest to produce them because it is so cheap to to transport them anywhere you want to use them or sell them.
So as a result, costs of of goods have gone down 50 to 90%, some in some cases, more than 90%. Now as a result of the of the geographic tensions, this big global is this globalization is going to reverse now, and it is in the process of reversal, and that is going to increase prices. So that's one thing that is driving inflation on the long run-in my mind. Secondly is the three d. So the globalization demographics.
Demographics, if if you look around at the map, you will see that the the mean age of of the population in The United States, in Europe, in China, in Japan. So anywhere where we see developed economies, the mean age is 40 or higher. When you look at the rest of the globe, the mean age is 30 or lower. Sorry. No.
I don't mean mean. I mean, median. Median age. So as a result, the the the supply of new skilled labor where we need it, which is in the developed countries is going to become less and less and less, and it is increasing far and and people are growing up in the undeveloped countries, but there are not there is no education that the kind of education that we need to continue to produce what we're producing is lacking there. So for that reason, I'm saying that labor prices are going to rise in the developed countries fast.
And thirdly, the deficit. Right? Deficit is looks like it's going to be $5,000,000,000,000 in The United States over the next five years. Now that the interest on that and that's added to the current 33,000,000,000,000. Right?
So it will be 38,000,000,000,000. The interest on that is is, you know, it's just going to grow higher and higher and higher. So inflation rate will increase for these three factor because of these three factors, you add ESG next to it on top of it, and then you see where you are. Right? On the other hand, we have AI.
It's a great promise, but I do not really see how that is going to help us out of here. But maybe it will I mean, I'm maybe I'm wrong.
You opened up the door to that, Thomas, given your background and, like, deep expertise on the digital and technology side. What are your thoughts around AI broadly, and how are you maybe looking to deploy that at your own firm?
So at our own firm, we have been trying to use different versions of AI over the last we started about three years ago for customer service. Namely, we ask our customer. We when customer calls in, we we we try to serve with them online, and we try to get them to type in the question, and then we give them an answer. And if they don't like the answer, they can switch to a customer service person. And that you know, right now, they about 3030% of our answers are correct, which is not bad because we started up something like two or three percent three years ago.
So it's it's it's getting better. And, you know, that is a demonstration that, yes, we can see we can save simple jobs like customer service. And so as a result, as as our number of accounts are growing, we don't really have to add too many new customer service people as that AI gets better. What is more exciting about AI, of course, is is what you all do, namely trying to predict stock prices. Right?
And there are a number of con shops that are working on that. And what we are doing is we're trying to interface their software with our execution software. Right? So that they they because what is going to happen is that as they see the data points changing, they will very quickly will want to act on it. But, of course, they are all looking at the same data points.
Right? So it's whoever gets there first is, again, it's it's always the fastest that's going to win. So it is important to have this this immediate ability to trade as soon as your data changes, you want the orders to to execute. So that's all.
That's great color. I now you talked about hire for longer being your base case. How are you managing Interactive's balance sheet for this new higher rate paradigm?
So we are invested very short term, roughly about a month forward. It is also right now, there is a very interesting situation in the if if you watch the long term bond market over the last ten days or so, you saw that long term interest rates came down by roughly 45 basis points to four fifty five from from 5%. Simultaneously, the stock market went up by about five five and a half percent. And so what is happening is that it it is institutional I assume these are institutional accounts who are betting on lower rates. So they are buying the the long term bond futures because it's very simple to very liquid, very simple to buy, and it's quick to buy, and you don't immediately need a lot of money to express your view.
So they are buying these futures. Now the hedge funds see the the the bonds trading lower than where the futures are, so they buy the bonds and sell the futures. On the other hand, when the futures are going to come due in December, what is going to happen? Right? So the the the institutions that bought the futures will probably not want to take delivery.
So they will either roll forward or just sell out. Now if they sell out, they they they the futures are going to dip. So the the the hedge funds that are holding the cash against the futures, we buy the futures and we want to sell the cash, but who is going to buy it? Right? So I think that come December delivery date, the rates are gonna go.
And if not this time, then in the March delivery. When you know, I think if you if you are interested in this, you should watch interest rates around the future delivery. What was your question?
No. That's that's honestly that's it's it's about how you're managing the balance sheet. But, honestly Right. Right. I hadn't heard that perspective in terms of the supply that's gonna hit the market and the dynamic with futures.
It's all about supply and demand in average.
Well said. The the other piece just around client engagement, given this macro backdrop, maybe just speak to what you're seeing in terms of trading volumes, but also the utilization of margin, which ticked higher as well as securities lending. So
margins if if the market stays where it is or goes slightly up, our margin balance will increase because margin loan balance will increase because we are the lowest provider of margin loans. We charge half a percent to one and a half percent over Fed fund rates. We charge one and a half percent for very small loans and half percent for very large loans, and for in between amounts, we are in between. If, however, the market goes down, then margin loans generally decrease because people liquidate or the some of some of those who don't liquidate, we liquidate them because we are our margin procedure is automated so that we never end up holding the bag.
And on securities lending, do you have
Securities lending. So securities lending, you know, it largely depends on the the number of hard to borrow situations. The the profits in securities lending are greatly dependent on that. And, currently, there aren't a hell of a lot of hard to borrow stocks. So but that's that's a fluctuate fluctuating thing, and, you know, you I cannot forecast what is going to happen.
Well, we'll hope for an IPO recovery that should hopefully help. Maybe just shifting to your business specifically, you've delivered consistently really best in class account growth. I know you've talked about 20 plus being the achievable bogey over the long term. Maybe just speak, Thomas, to the building blocks, how you get to that 20% growth sustainably.
So the the account growth for the last twelve months is 22% account, 24% equity. The the individual accounts have grown by 24% over the last twelve months. Nancy, are you here? Can you give me that my sheet? Yes.
So individual accounts are of 24%. No. 22 well, I don't I I I have to wait for the sheet.
I'm sorry. It's okay.
I wrote this all down on my on my laptop, and what happened was that instead of my presentation, I put out my Bank of America presentation. So the answers don't match the questions, so that's a
problem. Okay.
So individuals are growing at 24%, and prop traders, 21%, I brokers, 18%, hedge funds, 12%, and financial adviser, 7%. However, the the profitability of these segments is quite different per account because hedge funds are highest, rep traders are second, financial advisers are third, individuals are fourth, and I brokers are the least profitable. But so I I expect accounts growing at the same rate going forward as they have been growing in the recent past. I think
Well, despite not having my questions in front of you, that was my next question. So good job at least anticipating that. But maybe spending a little bit of time on the introducing broker channel, can you maybe help frame, Thomas, the the market opportunity for the broker dealers that you're targeting, and what's differentiated about your offering that's resonating with that cohort in the marketplace? So
80% of the accounts of Interactive Brokers are not US based. So only 20% of the accounts with us are American accounts. This and the the the growth, the new accounts are outside of The US even more than 80%, something like 84%. So we are basically an international broker because our accounts are coming from all over the world. And that gives us the advantage that we have very, very little competition in places where there is very little equity culture.
So people who are now coming to a point where they're beginning to have enough money to invest, if they look around, the the only advertisements they see for brokers is interactive brokers. So they open accounts with us. And that is the reason why our growth rate is faster than our peers.
Clearly, the challenges on the regulatory side, Thomas, create a lot of, very high barriers to entry for some of the other brokers.
And for us too because I tell you the the AML thing, of course, is extremely complex with with accounts from all over the world because The US applicant is very quick to AML online. Right? But with foreigners, the the online AML is is much more difficult, and we have to use people to to follow-up on these contact accounts. And so we have some 400 people now doing nothing but AML.
We've had, one interesting development is I know it's a very different demographic cohort, but Robinhood, who serves a very different clientele, is, launching in The UK. They have other ambitions to expand that more broadly internationally. Maybe speak to the competitive landscape and whether you perceive folks like Robinhood or others that are trying to make a similar push as meaningful threats in that regard?
So I was asked this question on CNBC two nights ago, and I answered saying that I do not understand Robinhood's business model because they have five times as many accounts as we have, and they repeatedly are reporting losses. And we have $3,000,000,000 of profits a year roughly. So I do I do not understand. First, they wanted to grow themselves to profitability, hoping that as they have more accounts, they they they they your cost will not increase at the same rate, but that didn't happen. So now they are trying to shrink themselves to profitability and trying to get rid of the least profitable accounts, but that doesn't give them profits either.
So how will they ever get to profitability is a very interesting question. And I tell you, I'm not going to do them do their homework. So
Fair enough. Well, we have them glad presenting later today. So
Oh, really ask him that. Right? And I am very much interested in what he's going to say.
And maybe just spending some time on the prime broker side. You noted that the hedge fund segment is the most profitable or at least has the highest profitability profile, I should say. What about the offering at Interactive is really resonating with some of the hedge funds? And are there any capabilities you're adding to maybe attract larger funds onto the platform?
So we we we are very lucky with the hedge funds because what happens is that the large primes will not take hedge funds under a $100,000,000, or you have to beg them. And if you have a related fund that's over a 100,000,000, then they'll take you otherwise. If you and most of the funds we get are under a $100,000,000. And so if you are in the under a $100,000,000 category, you have to go to a to a mini prime. And mini primes are they they don't clear or custody themselves, so they go between the the the big primes and the and the hedge funds.
And that, of course, adds to the cost, and small funds are are very sensitive to cost. Large funds are much less sensitive, and that is our problem. Because, basically, what we have to offer is better executions, more streamlined work, and less less expense. So we basically believe that we add 1% to the performance of a hedge fund. And large funds don't care much about 1%.
They care more about hedge handholding and all the wide glove stuff that they get from the major branch. So the second oh, what do we do about it? Right. So one of the things so we are trying to go after the large prime brokers for part of their business, which is that, you know, they can keep their custody wherever at Morgan Stanley or Goldman Sachs. But if they give some of their execution business and maybe a little bit of their custody to us, that's great.
And then they get access to our short availability where we are the only prime broker who display all of our short inventory and the rate at which you can borrow it. Now many of the funds look at that, and they instead of really doing the business with us, they go back to Goldman and Morgan Stanley and beat them up saying, look. Interactive brokers, then they stock at 2%. Why do you want four? Right?
And then they usually get what they say. But lately, I have heard that some hedge funds say interactive brokers gives me a 2%. Why don't you match them? And the fact is that we we have a stock of 3%. Right?
And the primes are picking up on the hedge funds lying to them, and they no longer match. So I don't know what will happen. But, anyway, we just came out. We are just coming out with the next week, we're coming out with a way to to from on your iPhone, you can enter the stock symbol and see the rate at which we are able to lend you the stock and the rate which we pay on the short proceeds and not only in US dollars, but also Hong Kong dollars or euros. So depending upon what where you are and what currency your account is based in because as I say, this is basically a global world, and, you know, America is only part of our service accounts.
Well, I know you've been climbing up the prime brokerage ranks. And now that the banks have to grapple with some tougher regulatory and capital burdens, I imagine there'll be a growing TAM at least at your side.
Thank you very much.
The shifting to the product side, Thomas, you've you've been an advocate for options trading for decades. The I've been right. You have been right. And, certainly, the adoption statistics support that. Is your expectation that the options utilization continues to grow as a percentage of trading on your platform and maybe even across the broader industry?
Definitely. I mean, that's that's that's that's what they've been saying. I started in the option business forty seven years ago, and options have been around for fifty years. The CBO started in '73. And, you know, throughout that those fifty years, you see almost straight line growth with a little bit of a curve upward in the last year or so, last two years.
And so the fact is that, as I say, where we are, where most of our new accounts come from is outside of The United States where options utilization is much, much lower. And there is so we are in a very good position to to market options. As a matter of fact, we do a lot of joint marketing with the CBOE and the CME at different places around the world. And so we have a very good situation as to where we are marketing. And I expect that this is going to continue to yield good good new options account.
And maybe on zero DTE options specifically, that there's been a that's been a significant tailwind to option volumes on your platform and and even broadly across the industry. Can you help investors under help us at least understand why short dated options have become so popular, and what's the runway for growth in your mind for that particular product?
So the reason is very simple. Short dated options are so popular because the shorter the option is, the cheaper it is. So people like to put up a $100 and see whether they are right or wrong by the end of the day with the zero day option, and they don't have to worry about managing the the position overnight because it's a cash option and it expires at the end of the day. So it's a very, very simple proposition to buy or sell an option. Now most of our customers are trading vertical spreads.
Namely, you buy SPY, you buy a a standard and push options. Right? You buy a 3,200 seller, 3,300 option. So your your your cost is is reduced by the if the market is around 32 something, your your cost is much less. And and so you're you're you're risking basically, you know, a $100 or something like that.
And at the end of the day, you either have a profit or a loss, and it's a lot of fun. Also, if you want to trade your way into a portfolio during the day, the market is kind of illiquid. So what people often do is if you wanna accumulate a portfolio, you you buy an in the money zero day call option, right, which is very liquid. And at the end of the day, you put in the portfolio order to buy on the close because you know that the that the option expires at the close. Right?
So when you buy on the close, you you get the price that you paid for the option, basically. So that's a and and the same way, liquidating a portfolio, you buy a put option.
Thanks, Thomas. I think one of the biggest differentiators in terms of your performance relative to the peer group is certainly your margins, which, I think last year when you were here, you said you don't know if there's room for expansion. They have since expanded. They're now in the the low to mid seventies type of zone. 73% to be exact.
Okay. That's a lot.
I appreciate the precision. 73%. How should we think about that margin trajectory in a higher for longer backdrop, confidence around the sustainability of that?
Well, we'd like you to be able to sustain it over the low 60%. I think it will be 60 to 75% for for the next next three, four years, and then it's gonna go as inflation is going to rise. As I said, it's going to I don't think we can go much higher than 75% because, you know, the the profit margin for the average US corporation, what is it? Maybe 10%. Right?
So it's it's impossible to to imagine that we could go much beyond 75. Right?
I would have said that last year too, that you wouldn't gotten much beyond, you know, the mid sixties. Yeah.
Yeah. Yeah.
So the but the the expense growth has actually been a big driver of that positive surprise even as the account growth has been trending in line with your targets. The that 15% growth in fixed expenses, you tended to deliver better than that. Why is the 15% the right benchmark? And can you sustain that even with the inflationary outlook that you just outlined?
Well, it no longer is because I think that our expense growth is going to be more like eight to 9% because the expenses grew very fast because we had to put in broker new broker subsidiaries in various countries, which we continue to do, but at a slower rate now. And second, I mentioned before that we had to very, very substantially boost compliance. The compliance department is is becoming almost the most expensive department of the firm. And so now that we it's it's all staffed and and we have put in a lot of compliance software, we can ease up on that expense a little bit. So our expense expense growth will come down to the eight to 9%.
That's great. Well, I know, Thomas, you only have one more minute here. I did want to ask you around M and A. You did note on the 3Q earnings call that you were looking at two potential M and A targets. Wanted to just better understand your m and a philosophy.
What are the types of companies you're interested in acquiring? Are they smaller broker dealers that you could fold into your current business, or is it more of a product capability ad that you're looking for from an m and a standpoint?
So as you read in the news, we haven't done any very well on that because there is no news. So we haven't done any m and a. And the problem is that, you know, we don't wanna get into the the the Robinhood situation where we have millions of accounts and not make any money. Right? So so so we we don't wanna buy any of these small brokers.
And, you know, the large brokers are more relationship driven, and we are not good at that either. We we we are good at building technology. So we're kind of stuck here. We we we would like we the money we have keeps accumulating. We are now at $13,600,000,000 of equity.
We and and we are making about after tax about 2,400,000,000.0 a year, and it just keeps accumulating on the bottom line. We have to spend it somehow or give it back as dividends, but we'll see.
Great way to close. Thomas, thank you so much for being here again. Really appreciate it. And next up, we will have the heads of Pershing. So thank you again.