While local Chinese fret over the bursting of the Shanghai stock bubble, global investors are more worried about the yuan currency which once seemed destined to rise inexorably.

A decade after China released the yuan from its peg to the dollar, ever more international money managers no longer regard the currency as a one-way appreciation bet that will augment their returns on stocks and bonds in dollar terms.

"For years, one of the arguments was that the yuan was undervalued and it would go up," said Zsolt Papp, client portfolio manager at JPMorgan Asset Management. This argument has been weakening for some time, he said. "That's added more volatility and uncertainty to your investment decision."

Foreigners have been fairly sanguine about the $2 trillion wiped off the value of mainland Chinese shares as they collectively hold less than 2 percent of the market. They likewise hold only an estimated 2 percent of the $6 trillion local bond market.

But they have major holdings in H-shares, the $3.7 trillion market in Hong Kong-listed stock of mainland companies, and "dim-sum" bonds, the $70 billion-plus market for yuan-denominated debt issued and traded offshore.

For years, many of these investments were built on the assumption that the yuan, as the lynchpin of Beijing's strategy to rebalance its economy away from exports and towards domestic consumption, would move higher.

Those bets have been rewarded: since 2005, the yuan has risen about 30 percent in nominal terms against the dollar. But this course is likely to be less smooth from now on.

A statement from the cabinet saying China would widen "two-way fluctuation" in the exchange rate to support trade provoked short-lived volatility. This sent yuan traded offshore to two-week lows against the dollar.

The People's Bank of China allows yuan traded domestically to rise or fall only 2 percent from a midpoint rate it sets daily. Offshore yuan trade is not constrained by this band, although in practice the two exchange rates usually move in lockstep.

Non-deliverable forwards, derivatives used to lock in future exchange rates, indicate the onshore yuan 1 percent weaker in a year.

China could probably benefit from a weaker currency. Its economy is growing at the slowest pace in 25 years and rival exporters, Japan and South Korea, may enjoy an upper hand thanks to the weak yen and won.

By contrast the yuan is near record highs in real effective (REER) terms - versus the currencies of trading partners and adjusted for inflation - having risen steadily since its fixed peg was loosened in July 2005.

Barclays calculates the yuan is 18 percent overvalued and sees it at 6.35 per dollar by the end of this year compared with 6.2 now, assuming the trading band is widened to plus/minus 4 percent.

Expectations that the currency will depreciate could increase demand for hedging yuan-denominated assets or cash flows, while reducing appetite for dim-sum bonds and H-shares, Barclays predicted.

NO BIG BETS

Beijing may be far from sanctioning big devaluations, however. It is keen for the yuan to be included in the International Monetary Fund's SDR basket of reserve currencies following a review in November and is therefore unlikely to allow sharp exchange rate swings in the meantime.

In the past, China has come under pressure to let the yuan appreciate, particularly from U.S. politicians who believed it was keeping the currency artificially weak to gain a trade advantage. Beijing would probably be anxious to avoid reviving such criticism.

Another sticking point is the $1.7 trillion in total Chinese foreign debt, of which 70 percent is classed as short-term. A weaker yuan would make it harder for Chinese borrowers to service this debt.

Perhaps most importantly, devaluation expectations risk scaring away capital following huge recent outflows. About $400 billion may have fled China this year, Goldman Sachs calculates.

Outflows and the resulting instability will outweigh any export gains a weaker yuan delivers, many argue.

Also, a weaker currency will not boost trade much because China, already the world's biggest exporter, wants to move into higher-value goods, says Ronald Chan, chief investment officer for Asian equities at Manulife in Hong Kong.

"By depreciating your currency, you are just going down the chain, not up the chain," said Chan, who does not hedge yuan risk.

RECONCILED

Investors have become more reconciled to yuan volatility since early 2014, when authorities engineered falls in the currency to discourage speculators betting on yuan gains.

The yuan fell about 2 percent to the dollar last year, its first year in the red since a tiny 2009 loss.

Chinese policymakers' inability to stem the equity rout has also been a revelation, said Salman Ahmed, global fixed income strategist at Lombard Odier.

"Until a year ago yuan was seen as a one-way street. Everyone knew about issues in the economy but also that they had $3.9 trillion (in reserves) to backstop any spillovers. Trust in that shield has been shaken," he said.

Ahmed is willing nonetheless to hold bonds, betting on interest rate cuts. China's yield premium, or carry, also remains alluring - 10-year government bonds yield 120 basis points above U.S. Treasuries with similar maturities, for instance.

David Buckle, head of quantitative research at Fidelity Worldwide Investment, says the carry will offset the impact of a small 3 percent band widening. But he sees risks in 18-24 months' time if China continues cutting interest rates.

"It's highly likely the U.S. will have raised rates by that time and that's when I can see an environment where the yuan weakens," Buckle added.