Japanese shares¡¯ ascent to record highs at the start of the year has reinforced a Fidelity International fund manager¡¯s preference for smaller AI-related companies that still look affordable.

The $944 million Fidelity Funds Pacific Fund, run by Dale Nicholls, has about 23% of its investments in Japanese stocks, the most for any country. It¡¯s beaten 96% of its peers in the past year, data shows. One of its top holdings is Fujibo, which makes polishing pads needed for chip devices and the company¡¯s shares have risen twice as fast as the benchmark Topix index in the past year.

¡°Japan is always a great stock-picking market,¡± Nicholls said in an interview. ¡°If you look into it, there are many names in the tech space, particularly at the smaller end. I still think their competitiveness is under-appreciated.¡±

Huge global demand for artificial intelligence has resulted in surging share prices of memory chipmakers whose products power the AI boom, like Sandisk in the U.S. and Samsung Electronics in South Korea. That¡¯s made them relatively expensive, opening the way for less pricey stocks of smaller firms like Fujibo who have businesses that are essential for AI.

Fujibo, which got its start as a cotton spinning company in 1896, now generates around 45% of its revenue from its polishing materials business. Its polishing pads are used for items such as LCD glass needed for smartphones, hard disks and silicon wafers for semiconductor products.

The Tokyo-based company has soared 80% over the past year, exceeding the Topix¡¯s 32% gain and the 39% advance in the Topix gauge for small companies. Yet Fujibo¡¯s price-earnings ratio trades at about 20 times, just slightly higher than companies in the Topix index, and still lower than the Nikkei 225¡¯s P/E of 23 times, indicating it may have scope to rise more.

While Japan¡¯s chip device makers aren¡¯t the biggest in the world, ¡°you¡¯ve still got strong market positions in parts of the supply chain that are very critical,¡± said Nicholls, who joined Fidelity in 1996. He¡¯s expecting further gains in small-cap companies that are benefiting from emerging AI-related businesses.

Generally, smaller shares pose higher risks for investors than large caps, because they tend to be more volatile and lower liquidity can make it harder to conduct big sell orders when needed.

Indeed, Nicholls¡¯ ten largest share holdings are led by industry giants Taiwan Semiconductor Manufacturing Co. and Samsung Electronics. Still, he sees opportunity in smaller names.

¡°I do think there¡¯s room to increase weightings there,¡± he said. ¡°I¡¯ll say that I¡¯m increasingly finding more opportunity in Japan amongst the smaller caps, particularly in growth areas.¡±