U.S. index provider MSCI could catch many global investors unprepared if it decides this week to add Chinese-listed yuan-denominated shares to one of its key benchmarks.

    For funds with little experience investing in China’s US$9 trillion stock market, such a move could be disruptive and costly, as they may become vulnerable to liquidity squeezes leading to a rise in tracking error and underperformance, investment experts said.

    MSCI will announce June 9 whether it will push ahead with plans to include China’s A shares in its Emerging Markets Index, a decision that MSCI says would draw US$400 billion to China stocks over time.

    Some of the biggest funds have prepared for this day. Firms including UBS, Invesco, Deutsche Bank and Schroders have already secured special licenses to buy A shares, denominated in yuan.

    For funds that have fallen behind the curve on China, however, the inclusion of A shares would be something of a shock.

    “Inclusion may create a number of new investment risks for international asset managers that don’t have the right set-up,” said Francois Perrin, head of greater China equities at BNP Paribas Investment Partners in Hong Kong.

    For starters, funds will have to do a lot of equity research to become familiar with more than 2,500 Shanghai and Shenzhen-listed stocks, which means working with Chinese companies’ different accounting practices.

    “The key is to know what you are buying there,” said Joe Quinlan, chief market strategist U.S. Trust, Bank of America.

    Funds will also have to get to grips with China’s investment quota system, trading rules, operational quirks, recalibrate risk models and re-write client agreements.

    This week’s decision comes at a particularly wild moment for China’s retail-dominated equity market, which has enjoyed a seven-month record-breaking rally even as China’s economy has slowed.

    According to Axioma, which provides risk management and portfolio construction tools, China’s A shares made up the second riskiest equity segment globally as of June 2 when measured by a range of factors that help determine short-term volatility.

    Anticipation that MSCI would add A shares to the index, which is tracked by US$1.7 trillion of funds, increased following the November launch of the Hong Kong-Shanghai stock connect trading program.

    Hitherto foreign institutions could only buy A shares through licensed investment quotas, but now foreigners can also buy via the cross-market program.

    While the stock connect program has helped open up China’s capital market, many asset managers oppose adding Chinese shares due to difficulties moving money in and out of the country.

    Given the reservations harbored by many funds, some asset managers expect MSCI to decide against including yuan-denominated Shanghai and Shenzhen stocks for now.

    This would be a relief for many global managers who have long-been underweight China equities, some of which can be bought offshore, and have failed to invest in China expertise.

    Specialized financial recruiters said they had seen a surge in demand for China expertise in recent weeks, as funds wake up to the prospect of A shares being included in global benchmarks.

    “We have seen a broad range of roles in increased demand by buy-side clients, including chief investment officers, portfolio managers and analysts,” said Russell Kopp, Hong Kong-based recruiter at executive search firm Whitney Correlate.

    FTSE Russell, MSCI’s chief rival, said two weeks ago that it would not force funds tracking its emerging markets benchmark to move into A shares, because of a lack of preparedness among many clients. (SD-Agencies)