Earlier this month, the Bank of Canada announced it was raising its key interest rate from 1% to 1.25%, with Governor Stephen Poloz indicating that Canadians should get comfortable with the possibility of more hikes to come. Canada’s largest financial institutions have since followed suit with similar increases in their key rates.
What does that mean?
Following the 2008 financial crisis, central banks lowered their rates to help stimulate the economy and pull us out of recession. Now that many economies are back on stable footing, the banks are returning to higher lending rates that support a higher growth economy. The Bank of Canada has pointed to solid economic reports, including strong employment and GDP growth, to justify last week’s modest increase.
This doesn’t mean that if you take out a loan tomorrow it’s going to be 0.25% higher than it would have been a week ago. The key interest rate is not the rate you as an individual get at your bank. This is a short-term rate, often referred to as the overnight rate, that major financial institutions use when lending to one another.
How could my investments be affected?
Generally accepted investment advice is that when interest rates go up, investors should avoid buying long-term, publicly-traded bonds.This is because there is an inverse relationship between a bond’s price and its yield.
It’s simpler than it sounds.
Say you invest $1000 in a newly issued publicly traded bond that promises a 4% yield. Next week, rates suddenly increase by a 1%. Now, new bonds issued are offering a 5% yield. If you want to sell your 4% bond, you’ll have a harder time as investors clamour for the higher rate. In fact, in order to sell your bond you would have to do so at a discount (for less than the $1000 face value that you initially paid) in order to sweeten the deal and bring the value of the 4% bond up to the same value of the new 5% bonds.
In reality, in an economically stable country like Canada, rates aren’t going to move much over a short period of time. For example, the Bank of Canada’s 10-year bond was trading at 2.167% prior to the 0.25% rate hike. A week later, it was trading at 2.22%. In other words, the 10-year bond only moved by 0.05% following the increase.
And just to reiterate, fluctuations in value and price only apply to bonds on the public market, bringing us to...
Are my CoPower Green Bonds affected?
Our bondholders can rest easy knowing that the value of their Green Bonds doesn’t change, as private investments aren’t exposed to the ups and downs of the public markets.
This is why, depending on your particular financial circumstances, adding private investments to your portfolio can provide diversification benefits. By sacrificing liquidity -- CoPower Green Bonds are held until the maturity date -- investors protect a portion of their investment portfolio from market fluctuations.
Will future Green Bonds be affected?
The other question we receive from investors is, if the Bank of Canada raises rates, will CoPower lend to clean energy projects at higher rates and therefore offer higher interest bonds?
The Bank of Canada’s key lending rate is the rate at which financial lending institutions lend to one another. Regular citizens and businesses are not directly exposed to the key rate although this rate does influence others in the market such as mortgage lending rates or savings rates offered by banks. These lending rates go up over time, but they do not move in lockstep with the key rate. It takes a bit of time for the ripple effect to work its way out to smaller transactions.
In our particular case, while our lending rate could theoretically rise, it is unlikely that this will happen in the near term for other reasons, namely the downward pressure on rates in our area of clean energy project finance. As clean energy matures, more and larger lenders become willing to enter the market. This is partly due to the increasingly attractive economics of clean energy and the mainstreaming of these technologies.
This is a positive development and speaks to a core part of CoPower’s mission -- providing loans that support the mainstreaming of clean energy project finance.
In the near term, you should not expect our interest rates to rise, as the rate at which we lend to projects will continue to face greater competition in the market. It is our job to make sure that we remain a competitive source of financing in the market, and manage our portfolio of loans to ensure our bondholders are receiving their fixed rate of return.
Making sure our work and investment products are impactful means adjusting to the changing dynamics of the clean energy industry. Our commitment to investors is to continue to create products that are both attractive to our clients while providing the catalytic financing needed to accelerate Canada’s clean energy transition.
Jennifer Macdonald is CoPower's Manager of Impact Investing. With a ten-year career in investment banking and portfolio management, Jennifer is our resident investment and finance expert. Chances are if you’re planning on investing in our Green Bonds you’ll end up emailing or on the phone with her at some point. You can read more about Jennifer here.
Lauryn Drainie is CoPower's Manager of Marketing and Engagement, helping build a community of individuals investing for profit and planet. Lauryn's passion for fighting climate change stretches back over a ten-year career in community and online organizing. You can read more about Lauryn here.