David Einhorn of Greenlight believes the markets are deteriorating.

On Wednesday at the Delivering Alpha event, CNBC's Leslie Picker interviewed Greenlight Capital's David Einhorn.

Value investing is a familiar theme that Einhorn often discusses, and in his recent talk he touched on the election results, inflation, and some of his current stock picks (including CNH Industrial and ).

"The hedge fund manager informed Picker that the situation is deteriorating and the professional asset management industry is undergoing a secular decline."

Passive investors are indifferent to the value of their investments.

Markets are 'broken'

Einhorn believes that markets are "broken," a statement he has made multiple times this year.

"In February on Barry Ritholtz's Masters in Business podcast, Einhorn stated that he believes the markets are fundamentally broken. He argued that passive investors lack the ability to form their own opinions about value and instead assume that everyone else has already done the work."

According to Einhorn, the S&P 500 index fund has contributed significantly to the growth of technology stocks, leading to a decline in value stocks.

The emphasis on earnings growth is skewing markets, according to the Cornell graduate.

"You have these companies that manage expectations, and they beat and raise expectations repeatedly, and they're good companies, and they're trading at 55 times earnings, even though they're growing at GDP plus two percentage points. This is the gamification of the market structure change, right?"

Many value investors, including Einhorn, are experiencing significant pain as cash is leaving their funds.

According to Rob Arnott, chairman of Research Affiliates, value stocks have been becoming cheaper relative to their underlying fundamentals while growth stocks have been commanding higher valuation multiples. Arnott is recognized in the investment and academic community for his work in asset management and quantitative investing.

Logical switch to passive investing

You can't blame investors for switching to index funds.

Passive funds are less expensive than paying an active manager, and research indicates that active managers have been underperforming their benchmarks for many years. In fact, a recent report from the SPIVA U.S. Scorecard, a benchmark study by S&P Global, found that 87% of large cap fund managers failed to beat their benchmarks over a 10-year period.

By switching from active portfolio management, passive investors in index funds are making a perfectly logical decision.

The frustration of Einhorn is comprehensible, as academic research has consistently shown that, in the long run, value outperforms growth.

Since the Great Financial Crisis, the long-term trend of growth beating value has been broken. For instance, the (IVE) has gained 286% in the last 15 years, while the (IVW) has increased by 610% — twice as much.

Value and active continue to lag

Profitability (growth) has become the primary investment metric for investors, surpassing traditional measurements such as P/E and value measurements like P/B.

Arnott explained to me that active managers, regardless of their style, have underperformed due to two primary reasons: higher expenses and the intense competition among them with minimal advantage.

"Fees and trading costs are higher for active managers, so their returns must be lower if indexers are removed from the market and the portfolio is left for active managers to own."

Active managers are facing stiff competition from other active managers, resulting in long-term underperformance.

"According to Arnott, active investors profit when there's a losing investor on the opposite side of their trades. Passive investors typically remain invested, so a successful active manager must have a losing active manager on the opposite side of their trades. It's like playing poker: any active manager who doesn't know who the losing player is, is that losing player."

'Free riding' passive

The claim that index investors are "free riding" on the price discovery of active managers is a true but unremarkable statement.

Although Arnott initially disagreed that they are free riders, he later argued, "So what? It's a cop-out to blame index funds and their customers because, from the customer's perspective, why should an investor NOT index?"

Arnott, who runs the RAFI indexes, emphasizes book value, sales, cash flow, and dividends, unlike other indexes that are based solely on market capitalization. He says this emphasis, particularly on profitability, has led to outperformance over time.

Most expensive market ever

Despite valuations at these levels, Einhorn is bullish.

"The 55-year-old told Picker that this market is the most expensive of all time, but it doesn't necessarily mean it will lead to a bear market. An overvalued stock market doesn't always mean it will go down anytime soon, and the 55-year-old is not particularly bearish. They can't see anything that will break the market at the moment."