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* Portugal, Greece shares and debt Europe's winners in 2014
* Inflows into funds invested there accelerate - Lipper
* Investors bet on recovery as both economies bottom out
* Benefiting from emerging market jitters, low returns elsewhere
By Francesco Canepa and Marius Zaharia
LONDON, March 24 (Reuters) - Yield-hungry investors are flocking back to Greek and Portuguese markets, shunned by international buyers for four years, as the outlook for the bailed-out countries improves and alternatives look more expensive or increasingly risky.
Portuguese and Greek shares and bonds have been the best performers in Europe in 2014, and funds invested in them are making a killing, Thomson Reuters data shows.
Investors say they are driven by economic improvement, which provides fresh impetus to an initial bounce triggered by the European Central Bank's pledge in 2012 to save the euro.
Potential investment alternatives are also less tempting. Tensions between the West and Russia and global growth concerns cloud the outlook for similar-yielding emerging markets, while a 1-1/2 year rally has shrunk returns elsewhere in euro zone debt.
"It's not so much an interest-rate-driven rally but much more a structural shift and a perception that the euro crisis is behind us," said Franz Wenzel, chief strategist at AXA Investment Managers, which manages assets worth about 550 billion euros ($760 billion).
After nearly crashing out of the euro zone in 2012, Greece's recession is easing, while the Portuguese economy is already rebounding. Lisbon is due to exit its international bailout in about two months.
Greece's ATG and Portugal PSI 20 stock indexes have been the best performers in Europe so far this year, having risen about 14 percent. The STOXX Europe 600 index is close to where it began the year.
Greek and Portuguese 10-year bond yields have fallen roughly 150 bps this year to roughly 7 percent and 4.4 percent, compared with 50-90 bps falls in fellow peripheral states Spain, Ireland and Portugal, whose bonds yield 3-3.5 percent.
While the small size of the Greek and Portuguese markets discourage some investors, it also means that a relatively modest inflow of money into those countries has a large price impact.
Funds invested in Portuguese shares, for example, took in a net 30 million euros in January, nearly as much as in the whole of 2013, after steady outflows over the previous three years, Thomson Reuters Lipper data showed.
Their asset under management, however, were still a meagre 381 million euros, or a quarter of what they were in 2007. The picture is similar in Greek stock funds.
Even after their recent rebounds, Greek and Portuguese shares trade at steep discounts to their European peers, based on the value of their assets, Datastream data showed. This compares with hefty premiums before the crisis.
Junk-rated Greek bonds still offer higher yields than those for the rest of the euro zone and emerging countries such as Romania and Hungary. Portugal's yield is comparable to Poland's.
Data from Markit, based on contributions from about 20,000 institutional investors with about $15 trillion under management, the ratio of long to short positions in Spanish, Italian and Irish bonds is already high on the expectation of falling bond yields, suggesting little room for a further rally.
The ratio on Spanish bonds shows investors almost as bullish as they have been in five years.
Research by Citi based on data from its network of salespeople shows that European asset managers were long or very long in Italy and Spain, while in Portugal, Ireland and Greece the same investors were only slightly long or neutral.
Japanese investors were still short or very short all peripheral markets, while hedge funds were longer in the lower-rated periphery than in Italy and Spain.
"Positioning is very aggressive ... in Italy and Spain," said Philip Tyson, a strategist at ICAP. "Portugal, that's where the juice will be, particularly as yields in Spain and Italy are very, very low right now."
While Greece and Portugal still have enormous debts, the progress they have made so far makes them a more attractive investment than many emerging markets, investors said.
Emerging economies are facing an uncertain future as the Ukraine crisis casts a shadow on eastern Europe, China's economy slows and the Federal Reserve curbs its easy money policy, triggering outflows from countries with weaker currencies.
This trend was seen as especially beneficial for Greece, which was reclassified by index operator MSCI as an emerging market last year and is set for a windfall as EM-focused fund managers cut their positions in countries such as Brazil, Russia, India and China, known collectively as the BRICs.
A Lipper basket of funds invested in BRIC equities suffered net outflows of 249 million euros in January, while Greek equities lured 22 million euros.
"If you go down the list of MSCI Emerging countries, a lot of them have their issues," said William De Vijlder, vice chairman of BNP Paribas Investment Partners.
"Then you have a country (Greece) that now has turned a corner and that makes it appealing for investors."
Since the start of the year, a FTSE exchange-traded fund (ETF) invested in Greek blue-chip stocks attracted net inflows equal to over a third of its current total assets under management, Markit data showed. ($1 = 0.7255 Euros) (Graphics by Vincent Flasseur and Francesco Canepa; Editing by Will Waterman)