Welcome to our next session. I'm Ben Budish, Barclays analyst, covering the U.S. brokers, asset managers, and exchanges. And with us, for this session, we've got Thomas Peterffy, Chairman and Founder, Interactive Brokers. Thomas, welcome. Thanks so much for joining.
Thank you very much for having me.
Maybe just to start out, can we get 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'm a long-term investor or have a time horizon of, say, 10 years, I think what 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 substantial upside in order to assure that. So I want to have 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 we move towards the election. Inflation, which is part of the stability question, will not come down, in my view, because of high debt service, deficits, de-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-induced stock prices will rise. So there are both sides of every coin.
Very interesting. All right, great. Well, let's spend some time talking about the company then. Maybe starting with account growth, which is really, you know, a unique kind of bright spot in your story, especially versus your peers. So I think you said you expect about 10% of account growth to come from word of mouth, another 10% from sales efforts, and additional growth on top from introducing brokers. So can you talk a little bit about the basis for this outlook? You know, what sort of drives the word-of-mouth growth? Talk a little bit about the sales, you know, 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, 10 is, you know, too smooth. I expect 10%-13% account growth from word of mouth and advertising, and as you know, 7%-10% from our sales efforts. Any additional growth would come from existing accounts or brokers who give up on building their own technologies and decide to be on board, decide to onboard as introducing brokers with us. Word of mouth is existing customers recommending the platform to their contacts, and the more customers we have, the more recommendations are made. Our 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.
The growth about this, the above this 20% may come from onboarding existing broker dealers who give up on continuing building their technology and their custody and compliance arrangements. Brokers like these have anywhere from tens to thousands to millions of accounts. Basically, I
Very helpful. So I appreciate the incremental precision, so it sounds like perhaps the marketing efforts are i s it fair to assume they're showing some signs of, you know, producing results? Can you maybe talk a little bit about what you're doing there? What does the strategy look like? And, you know, kind of beyond the key message of a lower customer cost, which we, of course, on the earnings calls, where 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 an automated. You know, we're big in automation, so we automate everything, and we finally automated our advertising. So what happens here is that we automatically gauge the yield in 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. 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, then we start to manage it along with all the already existing channels. And we find that it is per dollar advertising, we're certainly gradually improving the yield continued. So that's very refreshing. That's a good thing.
That's fine. Great. So maybe let's talk a little bit about retail traders, your, your kind of typical customer, if there were such a thing, retail activity in general. So maybe at a high level, how do you think the typical retail trader, as we understand it, will evolve? Maybe thinking about like from a product perspective, how sustainable is the growth in derivatives we've seen over the last couple of years, thinking particularly about short-dated options, but really derivatives in general, the, 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 thousands. We have many, many customers with thousands of dollars, but we also have quite a few with millions 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 investors. We must continuously demonstrate why the best-informed investors choose Interactive Brokers, which is our advertising bottom line out there that we had.
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 you called it Magnificent Seven, with huge unrealized gains, a lot of which you expect all to be written against. How long could this trend persist? You know, and how do you think about the risks where the market turn downwards more sharply?
So, obviously there are huge unrealized gains in these seven stocks, and, I think people are reluctant to take them because they don't want to pay taxes on the gains. So, a good strategy is to write options against, or write, sell calls against these stocks, maybe on occasion, buy puts if you're worried about them falling. But I think the overwhelming majority is the writing calls on the stocks. And as these stocks, I think, in the long run, are going to grow at least in parity with inflation. So I don't think that these gains will ever 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, a fair assumption?
So our stock trading has been declining. Our stock trading volume or customer 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, very cheap on all stocks, and that will never exceed 1%. So as a result, many of the people who wanted to trade penny stocks would come to us because everybody else would charge them 2%, 3%, 4%, 5%, 6% on penny stocks, and we only charged them 1%. So we had a lot of penny 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 options. So what happened was that our option trading volume has risen tremendously. Our stock trading volume has declined some. And now when you go to futures, everybody is saying: Well, look at 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 on the futures. So in reality, what has been rising is the options on the futures and not the futures volume. So Interactive Brokers customer futures volume has been declining by single digits for, say, the last year, but the options on the futures volume has been rising by more than. So it's options on both on futures and on stocks. People love options.
Interesting. So do you think it's fair to assume or I guess coming back to the original kind of question around trading too, the sort of sustainability around options trading in the retail customer base. Is there a lot more room to run there? Is would you expect that, you know, the retail trader who's engaged today is gonna 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 it?
So the zero expiration options are incredibly popular. And so if everybody is saying, "Well, how come, how come this is suddenly so such a big deal?" But the fact is that we had zero-day options 50 years ago when we started. Actually, 50 I think it's
Yeah, 50 years at least.
We had four zero day expirations a year because we had four expirations when we started. Then we went to monthly expirations, so we had 12 zero-day expirations a year. Then we went to weekly expirations, so we had 52 daily expirations a year. Then we went to weekly and end of month, so we had over 100 zero-day. And now we have 250 zero-day expirations. And I think they are incredibly. So first of all, they are cheap.
They are much cheaper than several day-long options, 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. And for people who want to take positions on the specific stocks, on the short term because of expectation of news announcements, it's a fantastic tool. So no, it's going to continue, and it's going to spread all over the world.
Well, it's a great lead into my next question. You know, this trend from a geographical perspective, and if we generally observe options activity at 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 the various geographies. So do you think the rise in options that we saw over the last, you know, many years, can that happen elsewhere? And if so, like or why or why not?
So I'm 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 1990s, European options exchanges, followed by Asian options exchanges, electronic exchanges opened. We became members of all these exchanges because we had this automated system that we couldn't really use to its full effect within the United States because they were all open outcry exchanges, and they used letters. So with these automated exchanges, we are able to plug in our computers, and we automatically drove all the bids and offers on all the options from 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 Swiss, and then it spread from there. And at that time, European and Asian options volumes were a lot higher than they are today. So what happened? What happened was that we had 30%-40% of the volume of all these exchanges in the 1990s, and the big banks didn't like it. So they went to the exchanges, and they said, "Please allow us to consummate all these option trades upstairs, and we will guarantee you that we will pick them up at your clearinghouse.
You can charge us the same fee as the group 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 spreads so that it didn't work for the customers. It worked for the banks, but they, within two years, they killed all the business because the customers were losing so much money that it didn't make any sense for them to do this anymore. So therefore, today, all the U.S. and Asian business is basically coming to the U.S. options exchanges. And what happens in the U.S. is that all the exchanges own, all the options exchanges own OCC, the clearinghouse. And therefore, OCC will not accept any trade that didn't take place on an exchange.
So there is some OTC activity that is still with the banks, and yes, you do still do an OTC option, but there's sort of make it very, very customized. So, it looks like it's incomparable, the price. They make the prices incomparable to the exchange-listed options. But the fact is that, the bid offer differentials, the imputed bid offer differentials are huge, and it's not a good business to trade on.
Very interesting. Maybe one last question, sort of on the customer behavior side. I'm just thinking about margin balances among your, your customer base. They've been kind of rising, you know, or fairly steady, sorry, over the last couple of quarters and still up pretty nicely since pre-COVID levels. So how do you think this could evolve going forward? Is it fair to assume the balance, you know, margin balances generally rise and fall with markets, or are there other factors to understand?
So that is exactly what we see. When markets go up, margin balance will increase. When markets go down, margin balances decrease. And this is even after two days of a downdraft, margin balances start dropping, and three days of up market, they start rising. 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%-1.5% over Fed funds 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 America together still have slightly more than that. And I do not understand. I mean, we advertise our heart out of this and have been doing this for years and years, and they still stay there, and they don't pay it. Either they don't pay attention, or they don't believe it, or I don't know. So through my answer.
The marketing seems to work. Hopefully, that starts to change.
Yeah, right.
Actually, you know, I wanted to pivot over, but speaking of the marketing, maybe one other thing I would have liked to ask about is your August account growth, which I think you have my understanding is you haven't seen any new Interactive Brokers clients or accounts flowing in yet in those numbers. So that seemed like a pretty healthy month. Would you attribute that to the marketing efforts, or was that sort of a function of how the market's performing? What sort of drove the-
It's probably both. So yes, the marketing effort is certainly improving. And, yeah, I mean, people sort of decided that we stopped going down just as it started going down again. But, so you're asking, and-
The particular strength in August, is that related to?
Oh, yes.
marketing efforts?
Yes, yes. Yes. So yeah, it was. It had nothing to do with. Yeah, it was just regular. It was a stronger month than usual. Much stronger, yes.
Maybe pivoting over to interest rates and impact on Interactive Brokers. So you spoke, a little bit in our conversation, your expectation that rates kind of stay higher for longer. I think you said something like that last year as well, which has been quite correct. So, how what is your view, maybe first of all, on how that's impacted trading activity and margin borrowing? It seems like your, you know, your rates are still quite low, but do you think a higher rate environment can impact margin borrowing in general? Or obviously, we've seen the opposite. We see overall balances higher than pre-COVID, but what are your thoughts there on how that sort of impacts the trading and margin borrowing?
Well, one would expect that these things have a great impact, but the surprise is that I haven't seen any as a result. So, you know, the trading behavior basically remained the same. Margin borrowing became, remained the same. We didn't see any difference, any change. And I know people, people had a change in their mind about how you view the market in view of the higher interest rates. The market doesn't seem to be paying any attention.
What about the sort of the impact, so like a financial question here, the impact on Interactive Brokers' P&L? You know, investors are always sort of asking, "Well, what happens when rates fall?" And maybe that happens at some point, perhaps it's farther out than assuming, but there's always a view that it takes a short-term, duration risk on your, investment portfolio, that you see a more immediate impact in that sort of environment. So maybe a high-level question, do you think yours will get the people on, like, the right margin profile for the business? I mean, you've definitely been investing as your margins have come up, helped by rates, but how do you, how do you sort of think about balancing those factors?
So if rates were to fall, we certainly would have reduced earnings because we have roughly $100 billion of cash balance our customers have. So we pay currently 4.83% on cash balances for larger balances, for balances over $100,000 of total assets. So the way we do it, we pay 0.5% on their Fed funds. Their cash balance is over $10,000 for any account that has assets over $100,000. If your assets in your account only are, say, $50,000, we pay you half it. If they are $30,000, we pay you 30% as much. If they are eighty percent as much, say, $80,000, we pay you 80% as much.
So, therefore, our interest income currently exceeds our every other income source. We have very little other income source other than brokerage commissions, right? So, we have substantial income from lending stock to people who want to short. And by the way, we also pay interest on short balances. If you short something and, you know, we hold the money as collateral against your short, we pay interest on that, and the same, at the same rate. So, yes, interest is more than 50% of our revenue, slightly more. Now, your question was about?
How you think about, like, the investing to a falling rate, consistent, so beneficial to your bottom line. Would you think about
So, as I said earlier, I do not expect the inflation rates to come down substantially. Certainly, I don't see it coming to percent, and we're just going to stick with the current posture of investing on the short term. Maybe we'll go out a little bit if we really interest rates could come down. But I think, I mean, why would I be any better at guessing than the market, right? The market is there. It's showing me what they are thinking, right? So far, because I didn't believe the rate's coming down, but I still don't.
Fair enough. It's interesting, I think investors versus three, four years ago, have definitely got to appreciate the sort of diverse approach to rate management versus what's happened with, you know, small banks, some of your peers. So it's funny how stories kind of change with you, kind of change the thing. Maybe moving back to your customers and, and kind of thinking about growth again here. So, you know, a substantial amount of your customers come outside the U.S. So maybe in the context of your overall account growth, we talked about that sort of 20%+. How much should be coming from international accounts, and are there any particular regions that you're targeting or that may be particularly appealing to the entry 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 4%-5%, so it is, accordingly, it's going to relatively shrink relative to other customers. And while 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, especially India, which is the lowest at $150 per year net profit per customer account, and everybody else is in between, with the exception of some very tiny poor countries such as Chad and Comoros, and I mean, where we have less than 100 accounts.
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, everybody in between.
Right. So it's, it's fair to assume that basically the correlation between average GDP per capita, average income
Yeah.
is a proxy for it.
Right. With the exception of maybe China. China or Hong Kong, they are higher than, t hey are pretty good.
Very helpful. On the topic of new customers, you talk a little bit about the introducing broker public business. So, you know, you've recently, I think in the past year, shared that you've got two large partners expecting to onboard this year. Any update you can provide to the timeline 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 to onboard just last week. So we actually had the first 17,000 accounts onboarding just on, I think it was on the eighth. Yeah. 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 $42.5 billion, of which the 17,000 accounts have $1.5 billion. The total amount of cash for the 52,000 accounts is $260 million. It's not a lot. This is the smaller of the two.
Now, the bad news is that the larger of the two is slipping to the first quarter of next year. So you're asking, why are they slipping? Well, you know, very large institutions and very many people, and everybody has to have their say. So, you know, they, everybody has to agree, and that is very difficult, and so everything takes a long time for them to do.
Understandable. Maybe kind of, you know, following up there, you know, the customers of an introducing broker partner, previously, they didn't have access to Interactive's suite of tools, global trading options. That's why the partner wants to partner to join your platform. So when they join, presumably, they're immediately less productive users. Maybe they're just used to trading 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 branded 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, you know, for the first, we charge so much for the first few trades and then less and less and less as, as the volume per account increases. Now, for introducing brokers, we take all of their accounts as though 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 now, when they come onto our 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 wants to think that the client is on their platform. So our platform is white labeled to them, and they don't know about Interactive. So it's up to them to market all the facilities that we have.
Very interesting. 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, you know, kind of recently as one of your other growth areas. Any recent notable trends? Are you seeing traction with newer, smaller hedge funds, maybe larger funds looking to add additional primes? And how do you feel your offering, you know, compares to your nearest competitors?
So I'm extremely comfortable in believing that when Preqin comes up in the next annual survey, we'll 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 JP Morgans, who have a 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 or charge a lot more, much more, or they go to BTIG or something like that, or they come to us, and our offering is much more as far as products and technology, is much more much better. 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.
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 well, we do some, but we don't do capping intro, and our research is not we don't have these kinds of meetings with CEOs and major founders. So, but we're working on that.
Interesting. What about on the financial advisor side? Are you seeing any pickup in activity? I think there's sort of an expectation that as some of the largest kind of players in the space have quite recently undergone a very, you know, intensive integration, that there's gonna 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 a high level? I think there's a lot of focus on retail trading and the hedge fund piece. How do you think about, you know, how the financial advisor piece sort of fits in?
We are continuously working on the financial. We're continuously expanding the technology that we are offering to financial advisors. The fact is that Schwab and Fidelity are very well, and LPL, are very embedded in that space, and it is proving to be difficult for us to get more of these folks. But you know, the new financial advisors, the startups, are certainly coming to us. So that's growing, but it's. I must tell you, it's growing at a lower rate than either the individual customers or the pro shops or the hedge funds are growing. It's growing at roughly 10% or so.
So, we're not very proud of how we have been doing there so far, but we are working on it.
Understood. That's encouraging to hear there's traction with, especially the newer upstarts.
Right.
And it's not like you're lacking for growth anywhere else, so there's that. Maybe one last question here, before we run out of time. You know, at one point, you were pursuing a bank license in Hungary, so you could offer margin loans that would be funded with customer funds instead of, you know, Interactive's own capital. As 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 some, you know, somewhere down the line? And could you maybe remind us of, of what the benefits, you know, what the, you know-
You will have to excuse me, but because of what's going on, I will have no comment on it.
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? You know, what are you sort of most excited about that's, that's sort of new on the tech side?
Well, we have done a number of things on the tech side. Namely, we have released our new Trader Workstation, and, as we just touched upon before, we are continuously upgrading our financial advisor software. We are working in a very concentrated fashion on our IBKR ATS, where we are allowing more sophisticated customers to try to cross their stock trades 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.
We are working heavily on the options, and there we are, trying to cross again, but the eventual cross has to be picked up on the exchanges, because as I said, for option trades to be cleared, it have to take this stage.
Well, Thomas, unfortunately, we're out of time, but thank you so much. Really appreciate having you here. What a great conversation.
Thank you very much, everybody.