Matthew Michael, a member of Schroders' emerging markets investment team, said the absolute return debt fund had the minimum sovereign dollar debt, no corporate debt and only the most liquid local currency bonds of countries with current account surpluses. The fund does not track any EM debt benchmarks. "Our current positioning is extremely defensive. We like the idea of emerging debt and we subscribe to all the long-term ideas about emerging markets, but in the short term there is misalignment between what people expect and what they will get in terms of returns," Michael told Reuters. He said hard currency dollar debt looked too expensive at current levels and pricing did not reflect the varied risk profiles of the different countries. The benchmark emerging dollar debt index, JP Morgan's EMBI Global, currently offers a yield spread of 400 basis points above US Treasuries. "We would like to take exposure but the question is whether we are being paid to take the risks. Yields are higher than in developed markets but we don't think they compensate for the liquidity risks and political risks, so there's nothing really there to interest us at these levels," Michael said. He predicted emerging markets would take a hard hit from any worsening of the euro crisis. Growth is also showing signs of easing across the developing world, from Brazil to China. "One of the things we do see is the risk of slowing growth in many EM countries going forward," Michael added. Schroders, however, likes emerging local debt, a sector that tends to pay higher yields and is likely to benefit from further interest rate cuts. But Martin said the fund had chosen this year to hedge exposure to EM currencies, while investing only in the debt of economically sound surplus countries. These include Singapore, Malaysia, the Czech Republic and Thailand. The fund is avoiding deficit countries such as Turkey, Hungary and South Africa. The currency bet seems to have paid off as heavy emerging currency losses this year versus the dollar have pushed returns on local bonds well into the red. The Schroders fund is up half a percent, Michael said. But it has missed this year's 9 percent returns on EM dollar debt, fuelled by gains in underlying US Treasuries. "With the kind of positioning we currently have returns will be limited but in the short term it's about not losing money. Our object is never to lose money," Michael said. Current conditions make it hard to predict how the sector would perform in 2012, he said. "I think 10 percent returns are achievable next year but we have a lot of volatility at the moment and there is no evidence this trend is finished."