Dietary restriction and increased physical activity are recommended for obesity treatment. Very low carbohydrate diets are used to promote weight loss, but their effects on physical function and exercise tolerance in overweight and obese individuals are largely unknown. The aim of this study was to compare the effects of a very low carbohydrate, high fat (LC) diet with a conventional high carbohydrate, low fat (HC) diet on aerobic capacity, fuel utilization during submaximal exercise, perceived exercise effort (RPE) and muscle strength. Sixty subjects (age: 49.2 ± 1.2 years; BMI: 33.6 ± 0.5 kg/m2) were randomly assigned to an energy restricted (∼6–7 MJ, 30% deficit), planned isocaloric LC or HC for 8 weeks. At baseline and week 8, subjects performed incremental treadmill exercise to exhaustion and handgrip and isometric knee extensor strength were assessed. Weight loss was greater in LC compared with HC (8.4 ± 0.4% and 6.7 ± 0.5%, respectively; P = 0.01 time × diet). Peak oxygen uptake and heart rate were unchanged in both groups (P > 0.17). Fat oxidation increased during submaximal exercise in LC but not HC (P < 0.001 time × diet effect). On both diets, perception of effort during submaximal exercise and handgrip strength decreased (P ≤ 0.03 for time), but knee extensor strength remained unchanged (P > 0.25). An LC weight loss diet shifted fuel utilization toward greater fat oxidation during exercise, but had no detrimental effect on maximal or submaximal markers of aerobic exercise performance or muscle strength compared with an HC diet. Further studies are required to determine the interaction of LC diets with regular exercise training and the long-term health effects.