MILAN, May 31 (Reuters) - Some European and U.S. fund managers are stepping back into Italian equities after fresh angst about a break from the euro zone wiped five months of gains off Milan's top share index.
Analysts expect uncertainty about Italy's role in Europe and worries over its finances are here to stay, keeping markets turbulent, but investors say that could make good companies cheaper, boosting returns over the longer term.
"In the last couple of weeks we've been investing a little bit more in Italy as prices have come down," said Luiz Sauerbronn, director at San Diego, California-based Brandes Investment Partners, where he helps manage $30 billion.
"We're long-term investors and if people sell off indiscriminately Italy, we see an opportunity," he said.
Brandes's European funds hold stakes in companies such as oil group Eni, cement maker Buzzi Unicem and Danieli, which builds steelmaking plants.
Italy-based global companies could be interesting picks, but so too are some domestically focused firms and banks, which were hit hardest during this month's rout, traders said.
After days of twists and turns, Italy on Thursday was awaiting a decision from the right-wing League party on whether to join a last-ditch attempt to form a government with the anti-establishment 5-Star Movement and avoid snap elections that would be focused on membership of the euro zone.
Worries that the parties' binge-spending agenda could put Rome on a collision course with Brussels, and that new elections could put Italy's role in Europe into question, have caused panic selling on the bond market and sparked record weekly outflows from Italian equities.
Possible bargains include Eni, cable maker Prysmian , caterer Autogrill or fitness equipment firm Technogym. Debt collector Cerved and well capitalised banks like Intesa Sanpaolo or UniCredit have become more attractive.
Their valuations have been squeezed in the sell-off.
Investors taking a constructive view on Italy, however, believe that checks and balances on its political system would make it hard for any government to blow up state finances, while they see a euro zone break-up as a remote option.
Gilles Guibout, who helps manage 746 billion euros ($871 billion) at AXA Investment Managers in Paris, believes volatility stemming from Italy's political instability is a risk worth taking.
"Italy is cheaper and has more earnings growth (than the rest of Europe). You must accept this extra bit of volatility but I believe that will be rewarded with better returns," Guibout said.
"Italy is systemic and I don't think it will leave the euro, but if it does happen it will be a problem for the whole of Europe and you would have to rethink all your euro zone equity allocation, not only Italy's," he said.
Two polls on Thursday showed that between 60 and 72 percent of Italians want the country to remain part of the euro.
In early May Italy's main share index was up 12 percent year to date, the best performer among top European benchmarks. On Thursday it was up 0.6 percent year to date.
Banks are also being eyed by bargain hunters but any move is seen as highly risky because their big holdings of government bonds have made them a target for hedge funds seeking to profit from a fall in their share prices.
"UniCredit for example is a very solid bank but I don't think turbulence is over," said Antonio Garufi at Decalia Asset Management in Geneva.
"We must be careful when our positions are being shorted and use volatility to our advantage," he added.
More broadly the key question is about timing.
Investors said purchases needed to be very gradual to avoid being trapped in any further sell-off or missing out on the chance to buy when prices are even lower. It's a matter of "buy now or wait", said JCI Capital fund manager Alessandro Balsotti.
Kepler Cheuvreux strategist Christopher Potts forecast this week that Italian stocks could fall another 10-15 percent.
"There is still a significant degree of downside risk attached to Italian financial assets because there are so few incentives for the investor to move to the buy side at this time," he said in a note. ($1 = 0.8565 euros)
Reporting by Danilo Masoni; Editing by Susan Fenton