By Laurence Fletcher

A handful of plucky hedge funds are nibbling again at cut-price Greek government bonds, increasingly optimistic that progress in talks between Athens and international lenders will deliver a better principle payout for bondholders.

Such funds think the bonds, which attracted few buyers after a second bailout in March inflicted heavy losses on private investors, may now be a bargain as hopes grow politicians can keep Greece on track to meet conditions for its cash lifeline.

Speculation that Athens may also get more debt relief, this time at the expense of public lenders and central banks, is also encouraging the interest from hardy, and discreet, buyers.

While market volumes are still low, with many funds opting to steer clear of such a bombed-out asset trading at barely 17 percent of face value, one manager - Adelante Asset Management - reckons that caution has been overdone; it doubled its holding in a basket of Greek bonds at around 14 cents some weeks ago.

The London-based firm's CEO, Julian Adams, had bought a first holding at 12.5 cents on the euro shortly before June's parliamentary election, aiming to turn a profit of a third by selling the position once the price reached 16 or 17 cents.

But although that initial target has now just been reached, Adams, whose firm manages about $110 million in total, has decided to stick with the play, raising his fund's exposure to Greek debt to 4 percent from 2 percent.

"It really depends on how events play out,» Adams acknowledged in an interview this week, but he saw prices rising another few points. «If events continue to play out, then the low 20s» would, he said, be a possible price for the bonds.

Adams bases his forecasts on the probability that Greece's cost-cutting plans will win approval from the troika of official debt monitors, while private bondholders could also profit if the European Central Bank accepts losses on its positions.

"Negotiations with the troika are going very well,» he said.

"It looks as though they're negotiating the necessary budget cuts for the next few years. It looks like they'll get agreement from the troika,» he added.

Approval from the trio of IMF, European Commission and ECB is key for public lenders in deciding whether to keep funds flowing - cash that could also improve eventual repayment prospects for bondholders. A Greek finance ministry source said on Monday approval was likely by mid-September.

Adams also sees a longer term boost from public lenders writing off some of Athens' debts: «The IMF has done debt simulations, which show Greece needs more debt forgiveness,» he said. «This will need to come from the official sector, which would be extremely positive for private sector bondholders."

Adams is not alone in building up Greek exposure: «There's a general feeling that ... there's a more favourable outlook,» one London-based prime broker told Reuters. He knew of at least one other hedge fund manager looking to add to its Greek holdings.

Yields on Greek government bonds maturing in February 2027 have fallen from 29 percent at end-May to below 23 percent. The bid-offer spread on 10-year bonds has narrowed to about 1 percentage point, demonstrating greater liquidity compared to spreads about twice as wide in May - and well down from highs around 9 points seen at the height of the crisis.

"We have seen a pick-up in volumes in the past three to four days, but they are still very low, around 10 to 20 million euros a day,» said one trader in Athens, adding that some foreign banks and «occasionally» hedge funds were buyers. Greece remains one of the euro zone's least liquid sovereign bond markets.

Greece is dependent on its second, 130-billion-euro ($160 billion) rescue deal to give it the cash to keep paying wages and other bills. Adelante's Adams said he expects an agreement to be struck between Greek Prime Minister Antonis Samaras and German Chancellor Angela Merkel when they meet this week.

Citing pressure on EU leaders to avoid haggling that could re-ignite panic over the state of Spain's much bigger economy, he said: «The deal will be cut this week over various dinners amongst the heads of government."

[Reuters]