Greenlight Capital founder: Markets are fundamentally broken by passive investors

David Einhorn, founder of Greenlight Capital, said the company was forced to shift its strategy as passive investors grew and algorithmic trading transformed the markets.

On Barry Ritholtz’s Masters in Business podcast, Einhorn said the markets are “fundamentally broken” because passive investors “have no opinion about value” since “they’re going to assume everybody else has done the work.”

He said investors are looking beyond active money managers and opting for passive investments that have lower fees.

Passive investments, such as index funds, made up more than 50% of the publicly traded assets in the U.S. by late 2019. Einhorn said that this would pose a problem for funds that invest in undervalued companies since fewer people are paying attention to individual stocks.

When investors notice a company’s potential, it drives up the stock. In addition, quants base their trades on short-term price movements rather than a company’s actual worth, he said.

Greenlight Capital gained 22.1% in 2023, and 36.6% in 2022, after 2015 losses that were caused by money flowing out of value-investing strategies and into index funds. The company is now also focusing on strong cash flows that fund share buybacks.

Einhorn also said that the regulatory infrastructure by the Securities and Exchange Commission (or SEC) is “essentially gone” since it doesn’t want the responsibility of acting against a public company that could blame the SEC if it takes a hit.

Instead, the SEC focuses on regulating hedge funds and cryptocurrency trades, and acting against individuals for insider trading violations, he said.

These are the 10 largest passive ETFs:

• SPDR S&P 500 ETF Trust (NYSEARCA:SPY) - AUM: $487.6B
• iShares Core S&P 500 ETF (NYSEARCA:IVV) - AUM: $432.9B
• Vanguard S&P 500 ETF (VOO) - AUM: $1T
• Vanguard Total Stock Market ETF (VTI) - AUM: $1.47T
• Invesco QQQ Trust Series I (QQQ) - AUM: $247.1B
• Vanguard FTSE Developed Markets ETF (VEA) - AUM: $178.27B
• Vanguard Growth ETF (VUG) - AUM: $206.1B
• Vanguard Value ETF (VTV) - AUM: $156.9B
• iShares Core MSCI EAFE ETF (IEFA) - AUM: $106.49B
• Vanguard Total Bond Market ETF (BND) - AUM: $316.3B

These are the 10 largest active ETFs:

• JPMorgan Equity Premium Income ETF (JEPI) - AUM: $31.8B
• Dimensional U.S. Core Equity 2 ETF (DFAC) - AUM: $25.14B
• JPMorgan Ultra-Short Income ETF (JPST) - AUM: $22.2B
• PIMCO Enhanced Short Maturity Active ETF (MINT) - AUM: $10.51B
• JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) - AUM: $9.93B
• Dimensional U.S. Marketwide Value ETF (DFUV) - AUM: $9.67B
• Dimensional U.S. Targeted Value ETF (DFAT) - AUM: $9.24B
• Avantis U.S. Small Cap Value ETF (AVUV) - AUM: $9.17B
• Dimensional U.S. Equity ETF (DFUS) - AUM: $8.35B
• ARK Innovation ETF (ARKK) - AUM: $7.8B