Focusing on backdoor beneficiaries of AI

A handful of large companies are garnering headlines and soaring in valuation based on their prominent role in the emergence of artificial intelligence, but Fidelity Portfolio Manager Neil Nabar sees better opportunity among some smaller firms that are further down the AI chain and cheaper, providing lots of potential to shine.

“I’m targeting what I refer to as neglected AI winners – mid-cap companies that can benefit from broad AI tailwinds, but with a stock price that is generally less expensive than well-known, large-cap counterparts,” explains Nabar, who manages Fidelity^® Mid Cap Value Fund (FSMVX) with Anastasia Zabolotnikova.

Nabar says he and Zabolotnikova seek long-term growth of capital in a valuation-conscious manner, with a bias toward high-quality companies. They believe that buying strong franchises, trading at discounts to the firm’s intrinsic (fair) value, can add value over time.

Data centers are a prime example of backdoor AI beneficiaries that fall squarely within their investment wheelhouse. To that point, Nabar highlights the portfolio’s stake in Digital Realty Trust (DLR), a real estate investment trust with a commanding position among large data centers in Ashburn, VA, home to an estimated 70% of the world’s daily internet traffic.

“Demand for data centers in this market is off the charts, and those that are well-positioned to meet the need stand to significantly gain as AI continues to grow in the coming years,” he says. Data centers supporting AI rely heavily on electricity to power their computing functionality, according to Nabar, while also keeping these facilities cool enough to operate the processors safely and effectively.

Consequently, the power data centers require is expected to rise sharply as companies rely on bigger – and more electrically demanding – AI models that can perform increasingly more complex functions, he says.

Along these lines, while demand for electricity is poised to significantly increase, supply likely will remain fairly constrained, given that there are no new nuclear power plants and few new electric power plants in the works, Nabar says.

While he expects capacity from renewable energy, including solar and wind, to grow, these sources can be somewhat unreliable because of their dependence on weather, he adds.

To capitalize on this supply/demand imbalance, the fund has maintained outsized exposure to Constellation Energy (CEG), the country’s largest producer of carbon-free energy and biggest operator of nuclear power plants.

“Nuclear power is green energy, putting Constellation in a sweet spot in terms of potentially securing business among large tech companies committed to net zero carbon targets,“ Nabar states, adding that the firm recently inked a deal to sell Microsoft nuclear power for its data centers.

He and Zabolotnikova have found opportunities among businesses that facilitate the high-speed information exchange AI requires. These include Coherent (COHR), a maker of high-speed transceivers; fiber-optics supplier Lumentum Holdings (LITE), and Wesco International (WCC), a distributor of cables and hardware needed for AI applications with tight specifications.

“We’re excited to discover potentially untapped value in segments of the market that are behind the scenes, but still highly integral to the AI revolution,” concludes Nabar. “None of these stocks was expensive at the time of purchase, and each has an important role to play as AI expands, laying the groundwork for a bright future.”

For specific fund information, including full holdings, please click on the fund trading symbol above. Securities mentioned were fund holdings as of February 29.