Utilitarian versus neutralitarian design of endowment fund policies

Abstract

This paper addresses investment and spending policies of endowment funds aiming to generate a stable income stream in perpetuity. The standard academic approach to the design of such policies is based on optimization of utility aggregated over time. However, the explicit purpose of many funds to serve current and future generations ‘in equal measure’ suggests incorporation of a suitable notion of neutrality. The utilitarian and neutralitarian approaches are compared in two settings: one in which the preferences of individual generations are described by a standard CRRA utility function, and one in which these utility functions are modified by the introduction of a saturation level. Results are expressed in terms of the implied assumed interest rate (AIR), which reflects the apportionment of initially available capital to the time-0 values of individual future benefits. Under CRRA preferences, the neutralitarian point of view can be seen as a way of determining the discount factor that is used in the utilitarian method. When a saturation level is added, the neutralitarian and utilitarian policies are essentially different. The introduction of saturation generally induces a shift of value from earlier to later generations.