HONG KONG (Reuters) - MSCI (>> Msci Inc) will begin to add overseas-listed Chinese shares to its emerging market indexes this month, drawing billions of dollars into such stocks, which could eventually lead to mainland-listed companies finding their way into global equity portfolios.

The index provider's decision in June not to include domestically listed China stocks, known as A-shares, in its global indexes, which are tracked by equity funds holding trillions of dollars, contributed to a sharp sell-off, prompting Chinese authorities to launch a heavy-handed rescue operation.

The inclusion of overseas-listed China shares, known as American Depositary Receipts (ADR), will be the first test of foreign demand for greater exposure to China since its markets returned to an even keel after a stormy summer.

Beijing wants to encourage more overseas capital into the mainland's financial markets, but foreign investors took a dim view of the market distortion caused by the government-directed intervention. Chinese shares listed on overseas markets, however, are not affected by such measures.

"Not only do they offer a great way to get into China businesses that are geared towards the consumption story, (but also) being listed in the U.S. means they are prevented from the kind of manipulation we have seen in the China markets over the summer,” said Marc Chandler, global head of FX strategy at Brown Brothers Harriman.

Analysts estimate the index rebalancing will trigger up to $70 billion in total flows into these stocks over the next six months and increase China’s weight in the MSCI Emerging Market (MSCI EM) index, which only includes Chinese stocks listed in Hong Kong, to more than 26 percent from just over 23 percent.

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Investors welcomed the move, which will give them exposure to U.S.-listed tech giants like Alibaba (>> Alibaba Group Holding Ltd) and Baidu (>> Baidu Inc (ADR)), which are more geared to China’s domestic consumption, which is still rising even as other parts of the economy, such as manufacturing, struggle.

"These are new-economy, creative companies, and investors will be excited about that, in stark contrast to many Chinese-listed shares that are more traditional state-owned-enterprise-type firms,” said Arthur Kwong, head of Asia Pacific equities at fund manager BNP Paribas Investment Partners in Hong Kong, who manages $1.8 billion in assets.

About a tenth of the potential $70 billion investment would flow in automatically via passive funds that track the indexes, but the rest depends on active fund managers, who are more circumspect after the events of the summer and wary of China's slowing economy.

About $1.6 trillion tracks the MSCI EM index, which is going to be most affected by the ADR inclusion.

“A lot of investors we speak to are watching this development very closely from the sidelines on what will be the ultimate impact for investors,” said the head of global index strategy and ETF research at a European Bank in Hong Kong.

Some investors might buy stocks that will be included in anticipation of the extra demand, but Lan said he had not seen any substantial flows so far.

MSCI will be the first index compiler to make such a move, and some market strategists say it could be a significant step towards the inclusion of mainland-listed stocks.

For the MSCI EM index, the inclusion of Chinese ADRs will reduce the weighting of stocks listed in India, Taiwan and Korea, which can therefore expect to see some selling.

The inclusion of ADRs in the second most affected index, the MSCI China Index, which tracks Hong Kong-listed Chinese companies and Shanghai and Shenzhen shares traded in U.S. and Hong Kong dollars, will come largely at the expense of financials, including ICBC (>> Industrial and Coml Bank of China Ltd), Bank of China (>> Bank of China Limited) and China Construction Bank (>> China Construction Bank Corporation).

(Reporting by Saikat Chatterjee and Michelle Price; Editing by Will Waterman)

By Saikat Chatterjee and Michelle Price