Key Takeaways
- Rolls-Royce is the best-performing UK stock over five years with gains above 1,000%.
- Higher interest rates and energy prices have boosted key UK sectors like banks and oil companies.
- Former ESG exclusions like tobacco and defense stocks have returned to favor.
The performance of the UK stock market has often tested the patience of domestic investors, especially with more lucrative returns available overseas.
But London’s “unloved” and “undervalued” stocks have started to catch up in recent years as a mixture of factors have combined in their favor. These gains have come despite UK political instability, war in Europe, an inflation surge and US trade tariffs.
The best performer over five years, Rolls-Royce RR, has returned more than 1,000%.
The Morningstar UK Index Doubles in Five Years
Despite the April tariff selloff, this year the FTSE 100 has hit multiple record highs and is close to breaching the 10,000 points level, having already gone above 9,000 points this year for the first time. Meanwhile, the Morningstar UK Index, a broader index of domestic stocks, has doubled in five years. The Morningstar UK Index has climbed 22.16% in the year to date through Nov. 28, positioning it for its best annual gain since 2009, when it climbed 30.48%.
Which UK Stocks Have Driven the Rally?
On an individual stock level, Rolls-Royce has been by far the best performer, up 1,414% cumulatively over the past five years, including dividends.
Rolls-Royce, with a 3.61% weighting in the Morningstar UK Index, has contributed 6.26 percentage points to its gains, making it the fourth biggest contributor to the index in five years
As a maker of commercial and military jet engines, the company has benefited from two key trends in the last five years: the surge in international travel and increase in defense spending following Russia’s invasion of Ukraine in 2022. Rolls-Royce has also undergone a transformation of its business attributed to Chief Executive Tufan Erginbilgic, who took over in January 2023.
Loredana Muharremi, equity analyst at Morningstar, says: “Since the pandemic, Rolls-Royce has significantly improved profitability, margins, and free cash flow, achieving targets two years ahead of expectations thanks to an industry recovery and operational and strategic improvements including optimization of long-term service agreements, improved time-on-wing for its engines, renegotiated contracts, and restructuring of its cost base.”
HSBC HSBA, the second-biggest stock on the London Stock Exchange and 7.42% of the Morningstar UK Index, has returned 336% over the past five years and driven 12.21 percentage points of the index’s growth.
After Rolls-Royce, in terms of absolute performance, UK banking group NatWest NWG has been one of the best performers, rising 500% over the period. Since 2020 the bank’s fortunes have been transformed: The UK government has sold off the stake in the company that it held since the financial crisis bailout, the name “Royal Bank of Scotland” has been jettisoned and the bank has benefited from higher interest rates and robust consumer spending and borrowing patterns.
Energy and Bank Stocks Have Outperformed
Sector performance has largely been shaped by macro trends, says Alan Dobbie, fund manager of Bronze-rated Rathbone Income Fund. He says the return of inflation in particular has created a different leadership profile when compared with the previous five years. Energy and financial services have the best annualized returns, between 19-20%. A rise in oil and gas prices, as well as higher interest rates, have helped these sectors, which have a heavy weighting in the UK stock market.
So far this year, the best performing sector in the UK has been financial services, up 31%, followed by healthcare, up 28%.
“The FTSE 100’s ‘old fashioned’ make-up is starting to work in its favor. Higher interest rates have turbocharged banks after years of underperformance,” says Jemma Slingo, pensions and investment specialist at Fidelity International.
The Backlash Against ESG Has Helped UK Stocks
Back in 2020, sustainability mandates meant UK heavyweights in defense and tobacco were largely avoided by investors, says Ben Russon, manager of Silver-rated ClearBridge UK Equity Income.
Since then, boosted by a surge in government spending, the aerospace and defense category has grown from accounting for about 2% of the UK market to between 5-7%, Russon says. British American Tobacco BATS has grown 153% and has been the sixth largest contributor to the Morningstar UK Index’s growth with 4.18 percentage points. Looking at 2025 in isolation, the stock is the fourth biggest contributor to the Morningstar UK Index after rallying 53%.
How UK Interest Rates Affect Stocks
In the last five years, UK interest rates went from a record low of 0.1% in the aftermath of the pandemic to 5.25% in August 2023 to tackle soaring inflation. Since then, interest rates have fallen back to 4%, with three quarter-point cuts this year. But the Bank of England’s cautious approach in loosening monetary policy has contrasted with the European Central Bank, which has cut the key deposit rate to 2%. Higher-than-expected rates in the UK have propped up bank valuations because of wider net interest margins.
UK interest rates are expected to be cut further in 2026, lowering borrowing costs for companies and individuals. Michael Field, chief markets strategist for Morningstar, says that lower interest rates should be supportive of equity valuations next year. The Bank of England is expected to make another interest rate cut when it meets at the end of December, taking the base rate to 3.75%.
The UK government bond yield curve shows the lower trend for short-term interest rates since 2024.
