Optimistic On AI, Calm About Yields – But Own Land – Thomas Peterffy

0:00I think if you think about how you want to invest your assets for your heirs to have something down the road, if these things happen that I'm worried about, then I think land is the logical asset. I think the Fed will probably raise rates, although I'm not, as I said, I would not be in favor of that. But they will have to do it just to demonstrate that they are independent. Slowing down, I mean, it's a very difficult thing because China is not going to slow down. So, you know, this is basically a competition between the two hemispheres and it's not, I'm not in favor of slowing down. I would like us to win.

0:57Welcome to the Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors, business leaders and politicians in the world, giving you our listeners. and Edge. The Master Investor Podcast is sponsored by LSEG, Interactive Brokers, the World Gold Council and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes. My guest today is a titan of markets, a digital trading pioneer who founded Interactive Brokers in 1978 and built it to sit at a market cap of$160 billion today.

1:49The performance in recent years in particular has been astonishing. Shares have risen over 40 % per annum for the last five years. Thomas still owns 75 % of the company and therefore is worth over$100 billion himself. IBKR Interactive Brokers is one of the four sponsors of this podcast, I'm proud to say. I am delighted to welcome back the chairman of Interactive Brokers, Thomas Petterfee. Thomas, great to see you. Thank you, Wilfred. Great to see you too. and you know I should point people because I was tempted because it's been a year year and a half since you last joined the podcast to recap your life story because it is so so fascinating but but rather than doing a repeat episode I would point people back to our first conversation just over a year ago for that and and Thomas I wanted to just start on a theme that has continued since then, and that is the amazing share price performance, which comes from an amazing underlying earnings performance, 40 % per year earnings growth from 2022.

3:03What's driven that? Well, it's basically what IBKR is all about. So when we started the brokerage business Some 33 years ago, we did that with the idea of providing a platform to floor traders on the various equities and options and commodities exchanges to continue their business as the floors go electronic. Now we were clearly way too early because the trading floors did not go electronic for another 10 years. Conversions happened between the year 2000 and 2010, and that was the time when we began onboarding our first target customers. So these were people with capital from half a million to five million dollars, and they conducted a regular daily trading business.

4:12So that our platform had to be very different than any other brokerage platform at the time, which were basically giving their customers order tickets to fill out. We had to provide a system for them, for our customers to manage several limit orders at the same time on different products. We had to enable them to do arbitrage and pair trading and shorting and all goes that professional traders regularly used to do. We had to obviously provide the best possible execution prices, low financing rates, high rates of temporarily available, untemporary available cash, interest on short proceeds, and all the features that these traders needed to make a regular income on a daily basis.

5:16As this business started to take off, we made our platform available to everybody else who could find us on the internet. And that included larger professional investors and hedge funds with substantially greater levels of capital and retail clients with much less capital. But the focus remained on the professional trader. And that is still our target client today. And they are the ones whose evolving needs we try to satisfy as we serve them in more and more countries around the world. so that is the reason we can say that the more investors know about the ins and outs of the mechanics of investing the more people the more people realize that in order to maximize their returns it is not enough to pick the right investment strategy but they also must pick the right platform to implement it.

6:31That is what drives our growth. I wanted to talk, Thomas, about two big themes, interest rates and AI over the next section of the conversation. First on interest rates, because clearly a big reason why your earnings have been so strong in the last four or five years is because your net interest income has risen as interest rates came off the floor for the first time in a decade. And clearly the market's grappling now with the prospect of whether rates are going to go higher still, possibly tomorrow with Kevin Walsh hosting a Fed meeting. It's so for us, it's not so much about how high interest rates go because we basically, you know, we lend money half over prime and we pay, not prime, I mean Fed funds, and we pay interest half under Fed funds.

7:31So we don't care if Fed funds are 5 % or 10 % or 20 % or 1%.

7:40But whether the Fed should raise interest rates tomorrow is a difficult question, And it's because in my mind, inflation is driven by oil prices and that higher prices are caused by the war. So stifling Iran's ability to attack the Strait of Hormuz is much more important to reduce inflation than to raise interest rates. And the bond markets call for raising the rates, but I'm unsure how important that is. It may be better to run a hotter economy while we are still fighting the war so that we can easier cope with unfavorable economic forwards. But when the war is over, we can see if lower oil prices immediately result in lower inflation or if we must raise rates at that time.

8:56Clearly, the longer end of the bond market at the moment is really flashing red. 5 % on the 10-year just crossed, higher still for the 30-year, and it's a global issue. How concerned are you about that? And does that trump the economic argument you're making? Does the Fed need to try and calm the bond market with a hike? Well, I think the Fed will probably raise rates, although I'm not, as I said, I would not be in favor of that, but they will have to do it just to demonstrate that they are independent. Are you worried about the bond market at the moment, the pace of increase in yields? No, I'm not.

9:45No, I'm not really. I mean, you know, increasing, it's fine. It's, you know, they can go anywhere. It's okay from my point of view. And you don't think it's going to, I guess, increase the chance of either a recession in the underlying economy or a big correction in the stock market? Well, if they rise very, very sharply suddenly, then that could cause all kinds of problems. But as long as it's gradually going up as it is currently, it's okay with me. And the last few weeks since, say, August, you think it is still gradual, the increase in yields? That's what I think, yeah.

10:53and use developing industry standards and market infrastructure. Learn more at goldhub.com. In terms of the other kind of big exposure, of course, to your very strong earnings growth the last four or five years, I think it's fair to say it's been a strong equity market, which is, you know, obviously something that boosts the overall momentum of your business. Do you fear about, again, the scale to which a single theme behind the equity markets, AI, is going to be hard to continue for the next five years in the same way as it has the last five years? so I wouldn't worry about that either because even though valuations are very high from a historical perspective if you look at the rates at which earnings are growing they are not high as a matter of fact they may be even too low so if you look at a company like Nvidia are 27 times earnings and their stated expectations of increasing earnings by 70%, that is a relatively low valuation.

12:17And a similar situation to a lesser extent is what we can expect everywhere else as AI permeates the economy. So it's not necessarily a focus on AI only, it's the use of AI with all other companies that will really drastically increase productivity and earnings. And even if the frontier models would stop progressing at this moment. There are so many open source models all over the place and adapting them by all the other companies will result in huge increases in earnings and productivity. So I'm basically very optimistic. And what about the big AI directly related companies, the hyperscales and the scale of investment they made in recent years?

13:20Thomas, you're quite famous in the business, which Wall Street has always celebrated for not wanting to waste money, to being very careful with the money you invest and making sure the return on capital is attractive. Do you think they've been foolhardy with some of their investments? Well, I mean, you know, it's an interesting situation because, you know, their idea is that there'll be only one or two of them who will basically prevail, right? But in order to be among the one or two winners, they basically have to buy all the compute capacity they can. So at this point, none of them are willing to give up on not being number one, right?

14:13So they have to keep buying compute and that eventually will contract the price of compute. So it basically is going to benefit tremendously everybody else. And these companies, of course, will have to write down much of the compute that they bought. And when you see the actions of the last week or so and the CEOs of these companies coming out to call for regulation, what's your assessment of that as someone that's built and sit atop a big business? Is it understandable to you to say, we want to slow down, we want to welcome regulation? Do you think that's a kind of understanding? The economy calculation is one thing, but slowing down, I mean, it's a very difficult thing because China is not going to slow down.

15:08So, you know, this is basically a competition between the two hemispheres and it's not, I'm not in favor of slowing down. I would like us to win. And similarly, what about the risk of a sort of Hindenburg moment, as some people are referring it to? And if there was something worse than the hugging face hack that appeared? I don't really believe in that. I mean, you know, hacks, they've been hacking systems for a very, very long time. And it hasn't really caused substantial problems. And you're a very tech-forward business, obviously. You've been massively ahead of the curve on all forms of trading.

16:03Do you worry about, I presume not at your business, but at a financial hacker in the financial system somewhere? Or do you in fact think that companies like yourself are investing heavily in this area and well-prepared for those threats? Of course, we're continuously worrying about it and try to take all the steps that we must take to make sure that we are not going to be hacked. But I mean, you can never be 100 % sure that that's not going to happen. You have to make sure that even if you do get hacked, it's not going to cause too much damage before you discover it.

16:51This episode is brought to you by LSEG, the leading global financial markets, infrastructure, data and analytics provider. To learn more about how LSEG connects businesses, investors and markets worldwide, visit lseg.com. Let's talk about prediction markets, Thomas. This is something that I know you've been passionate about, but I have to say I'd underpriced the scale of how long and how passionate you've been about it. You launched your prediction markets product forecast trader in 2024. You significantly increased the offering in 2025. But as I said, this was something you thought about over a decade ago and actually built a phantom prediction markets product 10 years ago.

17:43That's right, we did that. And then we were warned that if we were really bringing it out and offered it to users that we were at that time going where we were working on applying for a banking license and the consultants we used, they learned about our prediction market efforts and they warned us that if we go forward with it, we will never get a banking license. So we actually came out with it, but we came out with it with phantom money so that it wasn't real. But it was real enough for the guys at Kalshi and Polymarket to see it. And they said, wait, that's a great idea. And they came out with it for real money.

18:46And so that's what happened. And so now they are very ahead of us, of course. And when Koushi came out, you tried to buy them? That's right, because, you see, they went to the CFTC and they got licensed. And I said, what a stupid thing it is. I didn't think about doing that. And so I thought that, well, to get licensed by the CFTC would take about two and a half or three years. So I thought I'd rather buy them than do it myself. And I tried to buy them, but they wouldn't entertain an offer. So we went to apply for our own license and we got it. So they are basically, you know, most of the volume that they do is they are doing it in sports.

19:48We were never interested in sports. That wasn't our idea about prediction markets. prediction markets to us was all about how it should interdigitate with equity and commodities trading. And so you're focused, as you're kind of alluding to, on financial markets and where prediction markets can fill a gap for professional investors. You're right. So in our view, So the economy is the major determining factor for the stock market, right? And so the stock market and the commodity markets are only concerned with prices. And that doesn't answer all the questions about the future prices by themselves.

20:52They are a very limited niche. You have to understand, everybody understands that individual companies and individual commodities exist within a larger economy and regional economies exist within the country economy and country economies exist within the global economy and the global economy is functioning within a social and climate environment. And all those things are basically determining how individual companies can and do progress. So these questions, I think, are very, very important from a point of view of an investor. So when you are looking at a stock and trying to figure out where that company is going, I think you have to look at the entire environment and have an idea as to what that environment is going to look like in the future for that company in order to evaluate where that company can possibly go.

22:20How far away do you think we are, Thomas, from prediction markets being deep enough and liquid enough to genuinely represent overall consensus? I mean, I presume for a market like will there be a rate hike tomorrow, that's already the genuine consensus. It represents the genuine consensus. But what about questions? I know you offer markets on weather, for example, because it's relevant to commodities traders. Do you feel like they're deep enough and liquid enough to represent genuine consensus yet? Not as of yet, but I think in the coming years it is going to become more and more liquid. More and more, there are more and more economic interests that are dependent on these questions and who are exposed to these questions and who would do better if they could hedge.

23:20And therefore, they will pay more and more attention to these markets in the coming years and they will participate. And these markets are going to become huge in my view. Will it mean experts become kind of irrelevant? No, they will not be irrelevant because I think they will, instead of selling their expertise to whoever they are selling it today, they will just participate in the prediction markets and express their opinion that way because it's much more efficient. then yeah right they should take their own positions based on what they think and the and the prediction markets will tell the world what the experts think it it's i guess it's really interesting i guess we'll see who the accurate experts are they'll they'll uh put the money where the mouth is perhaps i'm interested in in how you run this business part of the business if it's not yet deep and liquid, does that mean you are more exposed at the moment to the positions that people are taking because you can't actively offset your positions?

24:42Yes. Well, to the extent that we have to make a market, yes, we are more exposed and it's not a very attractive business at the moment. but I think it will take off. And do you think that that also applies to the Calci's of this world or given that the higher volume for them is in areas like sports, are they deep enough and liquid enough that they are just simply making? They are so focused on the sports and they make a huge amount of money on the sports bets, but the question is, of course, as you know, the states are up in arms against them, and so it is going to be up to the Supreme Court, which I think will be decided in the late spring of the coming year as to whether these are swaps, the sports bets are swaps as the Kalshi's claim, or are they just bets that they should be licensed by the state to conduct these events.

26:09I guess with all of that, you might be pleased that you didn't buy Kalshi and even though it took longer to build. Well, if we had bought Cauchy, they wouldn't be doing sports. Fair enough. Fair enough. I guess the final question on this is how big you think it's going to be. I mean, what portion of your earnings and revenue is this at the moment? And in 10 years, even though you'll stay focused on the core markets that are relevant to professional traders and investors, how big can it be? I think, I don't know exactly 10 years, but in the fullness of time, it's going to be the majority of our earnings will be derived from prediction markets.

26:54market. Wow, really interesting. And I wanted to ask you on one prediction market that's live at the moment, because we touched on it last time we discussed. And so just to get your take, as I know, you're very plugged into the political situation. When we last spoke, you thought people were underpricing the chance of the Republicans holding both houses of Congress. Where do you sit on that at the moment? Well, it's still, I mean, the odds don't look good for people who are Republicans and it certainly doesn't look good. And do you think that market is deep enough yet to represent genuine consensus?

27:48Yes, the political markets are certainly deep enough to reflect the concerns. I think they are more accurate than the polls. And they're pointing to both houses flipping now? Well, no, they are pointing to the House of Representatives becoming Democratic and the Senate remaining Republican. We shall see what happens. I guess it's drawing closer every day.

28:24This episode is sponsored by BNY Investments. BNY Investments is part of BNY, a global financial services company supporting investors and institutions around the world. This sponsorship does not constitute investment advice. let's talk more broadly about your business and I heard this in a in another conversation that you gave to to a Bloomberg podcast and just what the single biggest risk to your business is that keeps you up at night that you think about every day that you have to focus on and you said that that was leverage. How often are you thinking about that leverage and the risk it poses to your business?

29:12Well, it's not as much leverage at interactive brokers. We are very automated and we continuously, our systems are continuously evaluating all the leverage of our customers and we immediately liquidate whenever there is any margin violation. But it's generally the leverage in the entire system that worries me because the fact is that other entities begin to have problems. It permeates through the markets and then everybody ends up with a problem. And where's your level of concern towards leverage in the system as a whole at the moment? The margin loans that are out there are very large.

30:22So the fact of the matter is that we don't even know. Part of the problem is that we don't know what's out there, right? Because there is not really a central place where it all comes together. And the problem is that many of these, of course, many of the banks are largely exposed to over-the-counter products. And we are not. But we don't do over-the-counter. We all interact with brokers, only those exchange-stated products that are cleared through clearing houses. So the problem always comes from the over-the-counter products where, you know, the bank has one contract with one counterparty and the hedge with another counterparty.

31:23And then when one of the counterparties become shaky, they sort of have trouble figuring out what to do. It's a spaghetti. Everybody's, you know, who has credit where. So that's where usually the problem is. And again, these problems get triggered when prices adjust very quickly and someone's been caught offside. And not to labor the point, but the rise in yields we've seen, whether it's in the US or Japan or the UK and the adjustments in some currencies like the yen, you don't think those moves have been big enough, enough of a surprise to somebody that it might catch people offside? well there's always a little bit of very but i so i i don't want to overstate this i i i you know i i'm not really worried about it at this time that i i don't think about it much and what about the threat ai poses to your business because you guys have always been you know the leader on the technology side of of of a brokerage offering uh great functionality attracting, as you said, those professional traders.

32:42Is that going to be easier to replicate by your rivals going forward in the age of AI? Will it also threaten your business? I don't think so. So we are interactive brokers has made AI available. All the major AI models are available to our customers. and they can interface with them and connect it to their portfolios and they can use AI to the best of their abilities via our platform. So this is a positive for us rather than a negative. So there is no... It's a benefit to our customers and it's good for our business. I'm not worried about AI from that point of view. I also do not think that AI in the near future is going to impact much about impact securities analysis to a great extent.

34:02because even though it's very, very good at bringing all the facts together and sorting them out, but it's not really good at projecting events forward. So the problem is with the current AI models is that the weights are all frozen. they are determined at the time of training and then they are frozen and they cannot be updated one at a time because the entire vector space is if you start changing something it becomes unstable so they are not enabling new information to come in and change any of the weights. So new information has to be accounted for, and it cannot... So basically these systems cannot learn.

35:16and that would be in my view absolutely essential for forecasting earnings and how companies will do in the future the current AI systems I don't think are applicable to that and that of course brings me back to the prediction markets because they are much more important for projecting earnings forward than the AI systems. Yeah, but I guess it'll be interesting in years to come if AI can also use what the prediction markets are suggesting GDP growth will be or recession chances in and factor that into their forecasts. I wanted to touch on your client base. We've been speaking throughout about how you tilt towards the professional client and in terms of the big accounts towards the hedge fund clients who are doing much more intensive trading and complicated trading.

36:26At the same time, you're now pursuing a new bank trust charter, not full banking license, but a trust charter. what's the thinking behind that? Is that to allow you to pursue the less sexy clients? So the bank charter is all about being able to custody mutual funds and ETS

36:57because you have to be a bank to be able to custody the assets of ETF issuers and mutual fund managers. And is that going to be a more, I guess the question I was trying to get to, is that going to be a sort of slightly more boring part of your business going forward? Well, it's not so boring because it has great repercussions for our ability to lend shares to customers who need them. Right. Because much of our interest income comes from short people who are shorting stocks. for whatever reason they do that. And that is substantially important for our performance. And the big custodians of this world, the Northern Trusts, the State Streets, the JP Morgans, what can you offer that they can't offer?

38:17What's your pitch to would-be mutual funds or ETS? We offer everything that they offer because as a matter of fact, we do it better because, for example, our short inventory is available to see online for our customers and they can not only see what we have, but also our lending rates they can see online. So now many people, you know, look and then they call the bank and then say, what do you mean it's 3 % that I can get it at interactive brokers or 2 %? And the bank says, okay, it's yours or 2%. But many of them then, of course, give us some business for that. Let's talk about your valuation.

39:13The share price performance has been fantastic. It's been built, as I touched on, on roughly 40 % underlying earnings growth per annum for five years. But also five years ago, the valuation multiple was much lower, it was sort of 12 times PE to 30 times or so today. Does that ever concern you that you're, although the underlying fundamentals are looking great, that it's unlikely the market will increase your valuation going forward? Or is it not really something you focus on? Well, to tell you frankly, I don't think about the stock much. I think about the business. I think about what kind of new things we can come up with and provide to our customers and how can we grow the business.

40:04Because the stock price, there's nothing I can do about it. And the idea is to have a wonderful experience for our customers and to make them as profitable as we possibly can. That is our focus. Well, and one leads to the other. So I think that sounds like a very sensible approach, Thomas. And I wanted to talk, if I could, about the assets you've diversified into. Clearly, as I mentioned at the top, you still own a huge amount of the company, which accounts for the vast majority of your over$100 billion wealth that makes you the top 20 richest people in the world. But you've also, and there's been quite a lot of coverage about this, in the assets you have diversified into, you've bought a lot of land, right?