The investment landscape for investors in UK funds has been challenging since 2016 due to a shrinking universe, fund outflows, regulatory changes, the rise of passive solutions and artificial intelligence (AI). The UK economy has also endured Brexit, the pandemic, rapid inflation, interest rate hikes and a new government, which has inherited a dysfunctional economy.
The political instability has added to the malaise, with the country enduring four prime ministers and six chancellors since 2016, with the new Labour government gaining power in 2024. Since Brexit, it has been both a difficult and unrewarding period to be a UK fund manager, but especially to be a sustainability focused investor.
A shrinking universe
The UK market has been weakened by a slew of takeovers, companies delisting and fewer IPOs. One in 20 listed UK companies were publicly bid for in 2024 with notable takeovers of DS Smith, Hargreaves Lansdown, Darktrace, Royal Mail (IDS), Direct Line, Britvic and Redrow. A total of 88 companies delisted from the main exchange in 2024, the highest number since the global financial crisis in 2008. To compound that, only 45 companies applied to join the market, of which 30 were approved by the regulator and the prospects for IPOs in 2025 look bleak.
The malaise has extended to companies already listed in London, with the decision by Unilever to list its ice-cream unit in Amsterdam. In addition, there is also the possibility that larger businesses such as Shell, Unilever, Relx, Prudential, BAT, Glencore and Rio Tinto may look to list overseas to achieve a premium valuation. The London Stock Exchange, itself a listed entity, is coming under greater pressure to improve the attractiveness of UK financial markets. The one large IPO scheduled in 2025, Shein, has come under scrutiny on the back of concerns over the sustainability of fast fashion and supply chain concerns in China.
Fund performance and outflows
Funds labelled as sustainable, responsible, ethical or impact have delivered underperformance over three years, with a quarter falling into the current list of ‘dog’ funds published by Bestinvest. The UK once again wins the wooden spoon with a quarter of funds with an ESG label highlighted for underperformance in the UK All Companies sector.
The worst performing ESG fund was nearly 50% below the benchmark over three years. Analysis of three-year performance data in the UK All Companies sector is even more damning, with 76% of ESG active funds firmly entrenched in the fourth quartile, with that number rising to 86% for five-year performance data. The surge in the price of oil on the back of geopolitical turmoil in Ukraine and the Middle East has been a headwind, along with strong outperformance in defence names which are normally excluded from most ESG funds. In addition, the small and mid-cap names, along with AIM, have been laggards, all parts of the market in which most UK ESG funds are generally overweight.
This, in turn, has had an impact on AUM within the sector. While equity funds brought in a record £27bn of inflows in 2024, UK equity funds suffered a ninth consecutive year of outflows. Although the £10bn of outflows was an improvement on the £12bn of outflows in 2023, the unloved UK market continues to suffer with fund closures and mergers on the cards in 2025. A total of £45bn has been withdrawn from UK funds since 2015, the last year the market saw material inflows of £5.6bn. The valuation story for UK equities remains compelling, but investors seem unconvinced at the moment and the near to medium outlook remains highly uncertain.
The rise of passive and AI
The UK has also not escaped from the rise of passive funds, and the spectre of AI is a large overhang for active managers. The former continues to exert pressure on fees and the latter has the potential to disrupt the whole sector from fund analysis to selection. Investors added nearly £30bn to index tracker funds in 2024, more than the previous four years combined. The underperformance by UK active funds will only serve to bolster the case for passives, with the latter offering significantly lower fees. Active UK managers are reeling from outflows and lower fees, both of which will affect smaller boutique investment managers, especially those focused on sustainability.
Regulation – SDR
The recent changes to the regulatory environment for UK sustainability funds in the form of SDR (sustainability disclosure requirement) will be another challenge for investment managers. The four labels advanced by the Financial Conduct Authority (Focus, Impact, Improvers and Mixed Goals) are designed to protect investors from ‘greenwash’ and help them make informed decisions. The initial take-up has been slow, with some prominent investment houses deciding not to pursue a label. The labels will only be useful if the majority of sustainability funds sign up, and there are concerns about how fund groups will evidence their adherence to a label in a standardised framework. Additionally, the absence of an ethical label is a surprise, given the long heritage of ethical investing in the UK, with the first equity fund launched over 40 years ago.
The regulatory overhang is another headwind for UK sustainable funds to overcome.
Outlook
The UK market has been under pressure for a considerable period, with its share of the global index shrinking from over 10% in 2000 to 4% today. Despite the FTSE 100 recently hitting an all-time high on the back of sectors that are normally excluded by sustainability funds, the past decade and a half has been dominated by the US. The wider sustainability industry will have to overcome the new Trump administration, which has signalled its anti-ESG bias.
The UK has been a leader in sustainability, but the poor performance of UK sustainable funds over three and five years remains a concern and it is difficult to see any meaningful near-term catalysts to relieve the pressure.
