Private capital flows to emerging markets in 2012 totalled around $1 trillion net, according to Philip Suttle, founder of Suttle Economics and until recently the chief economist at the Institute of International Finance in Washington, DC.

“From the flow data we can measure, the surprise is the lack of capital flows to emerging markets,” he says, noting that EMs received $1.3 trillion of private capital in 2007. “Flows are slow to recover despite emerging markets’ positive macro story and ultra-low interest rates in developed markets.”

His remarks are from a recent conference run by the Emerging Markets Private Equity Association.

Teresa Barger, managing director of Cartica Capital Management, and another speaker also based in Washington, says EMs account for 20% of global PE flows, up from 5% before the global financial crisis.

“One trillion seems low, given that emerging markets are the bright spot in the global economy,” she says, “but it’s high [proportionally] in historic terms.”

Suttle says weakness in Europe’s banking sector, which is in a prolonged cycle of deleveraging, may explain why PE allocations to emerging markets haven’t caught up to six-year-old peaks. “It has a way to go, but we may be at an inflection point in the US and Japan,” he says.

Brian Lim, Hong Kong-based partner at PE fund of funds Pantheon who also attended the conference, says investor concerns about China are another factor. “There is a worry about shadow banking,” he says, including an inability to calculate leverage in China’s financial system, where that capital is going and what happens to it if the economy slows too fast.

But, he adds, for Pantheon and its managers, China remains a destination, thanks to its consumer story.

Another reason for limited flows to emerging markets could be capacity constraints. Foreign direct investment is robust but portfolio flows aren’t able to keep up. For example, Barger says Cartica began investing in the Philippines in 2010, which she calls a “great trade, but too small for Calpers", referring to California’s $200 billion public pension fund.

This reflects investors’ falling out of love with big emerging markets, particularly the Brics – Brazil, Russia, India, China and South Africa. Smaller markets in Andean Latin America and Southeast Asia are hot, but too illiquid or insufficiently diverse for sizeable deals.

Lim suggests valuations are another reason for relatively weak flows. India, for example, is suffering from political deadlock, lacks liquidity and policymakers and business partners can’t deliver promises to GPs. Yet deal valuations don’t reflect these problems, and investors aren’t getting paid for those risks. “The promoters think they can get a big IPO success, but the valuations aren’t realistic,” he says.

Suttle thinks government policies play a role, both in emerging and developed markets.

Emerging markets “are running loose monetary policy by cutting interest rates instead of allowing their currencies to appreciate and thereby attract capital", he says, citing Brazil, with its negative real interest rates.

But perhaps even worse are developed-country monetary policies. Quantitative easing in the US, the UK, Japan and to an extent Europe is creating huge pools of liquidity that impact emerging-market credit conditions, fuelling shadow banking systems and setting up banks to make poor decisions around capital allocation.

Finally, the track record for private equity in emerging markets is disappointing, in general terms.

The industry saw early movers from the 1990s and early 2000s make a killing on exits during the boom years of 2003-2007, notably in places such as China and India. The vintages of 2006-2008 saw GPs raise lots of assets and cut corners on investments; they are left with plenty of dry powder (around $85 billion for China and India alone) that they now struggle to deploy. Expectations among investors and entrepreneurs are still adjusting.

Those emerging markets that improve their environment for governance, contracts and political stability will have more companies that make attractive PE investments.

Barger says emerging-market PE still makes sense versus developed markets because it achieves the same returns on capital, and the same internal rates of returns for managers, but without leverage. “It shows emerging markets are attractive,” she says, “if you’re in the top quartile.”

For a closer look at private equity in Asia, see AsianInvestor magazine’s June edition.

While still at IIF, Suttle calculated private capital inflows to emerging markets at $1.08 trillion for 2012, and he expects a modest rise to $1.1 trillion for 2013. He says $572 billion was PE investment, but of that, only $99 billion was in the form of portfolio investment. The rest was foreign direct investment (FDI). Another $502 billion went to emerging markets (net) in the form of private credit, of which only a third came from commercial banks. Official institutions make up the final $55 billion of net flows to EMs.