Capturing opportunity through factor rotation
Many active managers like to invest according to style factors like momentum, growth, value and size, but their cyclical nature means that each of these factors will go through a period of underperforming the market.
So what if there was a way to use signals like economic data points, valuations and investor sentiment to time when each factor may perform best?
This strategy is called factor rotation, and it’s becoming an increasingly popular way for iShares investors to get an edge in today’s volatile market.
With the outlook for US growth unclear as supply shocks flow through from the Middle East conflict, a strategy that quickly adapts to market trends may be beneficial in the months ahead.
How does factor rotation work?
BlackRock portfolio managers aim to outperform the US equity market benchmark by allocating across six key factors – quality, momentum, value, size, low volatility and growth. Each of these factors is backed by decades of economic research pointing to its valuable role in generating long-term returns for investors.1
Our team then uses data signals to work out which factor will likely outperform at any given time. The signals are based around three key predictors of performance:
1. Regime – Does the factor tend to do well in the current environment?
2. Fundamentals – Is the factor attractively valued, with strong underlying companies in terms of cash flows, profitability and sales?
3. Sentiment – Does the factor have a supportive or improving trend, based on performance, analyst views and investor positioning?
Finally, this outlook is translated into a portfolio of stocks that most efficiently reflect the factor view. For example, to take a positive view on quality and a negative view on size, we might select Stock A in the example below.
Source: BlackRock as of 28 February 2026. For illustrative purposes only
Why does factor rotation improve performance?
Over the long term, all six factors generate proven excess returns for investors above the benchmark. But in the short term, individual factors tend to perform differently as economic conditions change – for instance, momentum tends to perform best during periods of expansion, while quality may outperform when the economy is slowing down.
Factor rotation aims to eliminate this short-term underperformance drag on your portfolio, by timing the market to maximise exposure to the best performing style factor of the day.
As seen in the table below, since the strategy’s inception in the US, it’s been successful in doing this. The iShares U.S. Factor Rotation Active ETF (IACT), recently launched in Australia, mirrors the same strategy as the US DYNF below.
Total return – IACT underlying fund (DYNF) vs index and peers
Source: BlackRock, Morningstar as of 28 February 2026. DYNF performance is net of fees. *Total return of a hypothetical equal-weighted static combination of the following ETFs net of fees: iShares MSCI USA Quality Factor ETF (QUAL), iShares MSCI USA Value Factor ETF (VLUE), iShares MSCI USA Momentum Factor ETF (MTUM), iShares MSCI USA Size Factor ETF (SIZE), iShares MSCI USA Min Vol Factor ETF (USMV), ), iShares Russell 1000 Growth ETF (IWF). As the iShares U.S. Factor Rotation Active ETF (Fund) has an inception date of 6 June 2025, performance information of the Fund included in this material is created using data relating to the iShares US Equity Factor Rotation Active ETF (Underlying Fund). The Fund gains its investment exposure via an investment in the Underlying Fund, which has an inception date of 19 March 2019. Past performance is not a reliable indicator of future performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.
Adapting to changing markets
IACT underlying fund (DYNF) positioning (3 years, monthly)
Source: BlackRock as of 31Dec25. Chart illustrates monthly active factor exposures of DYNF vs. the S&P 500 Index for 36 months. Factor exposures are measured using the BlackRock Fundamental Risk for Equities Model (BFRE US). Factor exposures are shown as Z-scores, which are statistical measurements of the number of standard deviations the portfolio’s style exposure is away from the estimated total universe. From red to green, z-scores are categorized according to the following 7 ranges: <-0.2, <-0.1, <-0.05, <+0.05, <+0.1, <+0.2, >+0.2. Factors are represented by the style factors of the same name, with the exceptions of quality (profitability style factor), min vol (volatility style factor, inverted), and size (size style factor, inverted).
The chart above shows how the factor rotation strategy has navigated changes in factor leadership over the past three years, through an approximately monthly cycle of rebalancing.
Following the previous energy shock in 2022 when Russia invaded Ukraine, rotations occurred to quality and growth stocks, while more recently momentum and value have been in favour as US economic growth has picked up and earnings growth broadened.
So far in 2026, the fund has remained positive on momentum, while noting small signs of improvement in the size factor as sentiment around US interest rates has remained more positive than that of Australia.
Despite being traditionally associated with economic expansion, the momentum factor itself has adapted and navigated through markets and remained relatively resilient through volatility, with industrials now one of the top sector weights for the momentum factor.
The fund has also maintained an overweight in value, which performed well in the early part of the year as investors rotated out of expensive software stocks.
This positioning could change given the current uncertainty around supply shocks from the Middle East conflict. While we are yet to see the flow-on effect to US earnings, any contraction in economic growth could see a flight back to quality, or potentially low volatility stocks. This is why the ability to rapidly respond to market events can pay off.
Putting factor rotation to work
Factor rotation is one of the few strategies proven to offer consistent outperformance against the S&P 5002 – a notoriously difficult index to beat for active managers.
Combined with lower-than-average fees for an active strategy3, this makes it a comfortable way for investors who already hold index exposure to the US to consider blending active and passive strategies to improve performance.
As factor leadership continues to swing over the course of 2026 and beyond, IACT uses the power of data to allow investors to tap into the investment style that’s most likely to outperform.
