The 54-year-old, who replaced Jose Mourinho as Chelsea manager in September 2007 before being sacked the following May, was technical director at Portsmouth from June 2006 to July 2007.
Grant's return to Portsmouth followed the takeover this week by Saudi Arabian businessman Ali al Faraj which is expected to stabilise the club's difficult financial position.
He bought 90 percent of the club's shares from Sulaiman al Fahim who took over in August but was struggling to refinance the mounting debts.
Paul Hart will remain as manager.
"The club's new owners want to appoint, with immediate effect, Avram Grant as director of football," chief executive Peter Storrie said on the club's website.
"Avram's role is to help and advise Paul. Team selection matters will remain with the manager.
"We now have two very experienced people working together which will only benefit the club."
Grant's experience will be vital as Portsmouth try to make up ground after losing their opening seven league games of the season, the worst start by any top-flight side for 79 years.
"I am happy to return to the best league in the world, the English league," Grant told Israeli sports website, adding that he had signed a three-year contract.
Portsmouth, still bottom despite earning their first points of the season with a 1-0 win over Wolverhampton Wanderers on Saturday, are next in action against Tottenham Hotspur after the international break.
