Why do so many ESG funds invest in oil and gas?

It is not a secret that many environmental, social, and governance (ESG) funds invest in oil and gas companies. For example, iShares ESG MSCI USA ETF (ESGU), the biggest ESG ETF, has holdings in oil companies ExxonMobil and Chevron. The newly launched BlackRock U.S. Carbon Transition Readiness ETF (LCTU) also owns Chevron and Exxon.

The largest ESG funds generally try to mimic the broad market’s risk and return profile while adding ESG criteria. The broad market includes fossil fuel stocks. As a result, many ESG funds include them, too (though they pick fossil fuel companies with better than average ESG scores.) In other words, they invest in best-in-class companies in sectors that are not deemed ESG-friendly to replicate the broader market’s risk and return characteristics.