How do I best track and even buy a mutual fund of semiconductor stocks? The individual prices are so high they are discouraging. I'd like to come into a sound mutual fund if one exists. -- Dr. Paul Gross

Dr. Paul,

You'll need to steel yourself for vast swings in this historically volatile sector if you want to hold a basket of chips.

Wednesday's action is a good example. The

Nasdaq Composite

plunged 286.27, or 7.1%, and chip stocks fell right along with it. The

Philadelphia Stock Exchange Semiconductor

index fell 8.3%. Stocks like

LSI Logic

(LSI) - Get Report

and

Texas Instruments

(TXN) - Get Report

dropped 10% and 8.7%, respectively.

Now that's a good taste of turmoil for you.

Ask yourself if you can handle it. If the answer is yes, keep reading.

The semiconductor business is a cyclical one, and these stocks go from boom to bust in no time flat. For that reason among others, you won't find many chip-centric mutual funds.

Yet, some of the ones that do exist, namely

(FSELX) - Get Report

Fidelity Select Electronics and

(TVFQX)

Firsthand Technology Value, are time-tested and impressive.

The semiconductor, or chip, business is propelled and pummeled by the cycle of supply and demand. Chips are used in a broad array of electronic devices, including PCs, servers, cell phones and the equipment that connects the Internet and other networks.

Leader

Intel

(INTC) - Get Report

, for example, makes microprocessors that are the brains for PCs.

PMC-Sierra

(PMCS)

makes semiconductor components that boost speed and performance on the Internet and other high-bandwidth networks.

At the beginning of a business cycle, semiconductor companies will start to see rising demand for chips from their customers. As this demand increases, the supply of chips gets tight and the prices go up, which obviously benefits the chip manufacturers. To produce more chips and meet this demand, companies need to build more plants, but it takes 12 to 18 months for new capital spending to turn into new physical capacity or more chips.

"It's like trying to do a U-turn with an ocean liner," says Charles Boucher, a semiconductor analyst at

Bear Stearns

.

"There's the tendency for companies to sort of invest in a reactive manner to business conditions. They don't start to invest again until things are in tight supply. It tends to make the shortages get worse."

Once the chipmakers start churning out more product, it's usually too late. "Customers are induced to double-order and stockpile inventories and do some fairly unhealthy things with their businesses," Boucher adds.

The result: a chip glut. Too much product and too little demand causes prices to fall, and the chip companies start running into profit problems.

The length of these cycles can vary depending on the area of the chip market. To get a feel for the cycles, you only need to look at the chart of a semiconductor index or chip-heavy fund or a chip stock. That exercise will make your neck hurt. The most obvious example is what happened to makers of computer memory, or DRAM, chips -- the most commodity-like product -- in the mid-1990s.

Micron Technology

(MU) - Get Report

, a leading producer of these chips, peaked at the end of the third quarter of 1995 and then fell about 67% over the next three quarters.

Wednesday's bloodletting, however, was more a result of the broad tech tumult than a change in the immediate outlook for semiconductor stocks.

"Chip fundamentals are startlingly good right now," says Boucher. "I was calling my clients advising them to start buying more chips."

The Internet and wireless communications are major sources of growth. As communications infrastructure expands, chips are needed in the equipment used to build and expand networks like the Internet. They're also needed to make wireless handheld devices, like cell phones. Wireless penetration in the U.S. is still appallingly low at around 30%.

Some of these chips are extremely complex and perform very specific tasks. A chip that is more difficult to create and manufacture is less likely to become a commodity, and some say, less likely to be subject to cyclical trends.

Over the next two weeks, you will see many chip companies report their quarterly earnings, which Boucher believes will be good news for these stocks.

"I think you will see powerful evidence of growth in the first-quarter earnings that will be leading into the second quarter."

After the close yesterday, both

Advanced Micro Devices

(AMD) - Get Report

and

Altera

(ALTR) - Get Report

reported first-quarter earnings and beat analysts estimates. Altera was also added to the

S&P 500

.

"During the second half of the year, you should see an epic shortage on the supply side," Boucher adds.

Fund manager David Alger agrees. These stocks are in "a sweet part of the cycle now," he says. Alger is seeing 30% to 100% annual earnings growth per year in these companies. He says he has 15% to 20% chip allocations in several of his funds, including

(SPECX) - Get Report

Spectra.

As more evidence of their popularity,

Merrill Lynch

(MER)

just filed to launch a Semiconductor HOLDRs.

But that growth potential doesn't mean the chip business is no longer a cyclical one. "I know the arguments for why it is different this time. It's communications-oriented and the Internet is driving growth faster than anything else that has ever driven it. Blah, blah, blah," says Boucher.

"I think the

cyclical nature has nothing to do with where the demand is coming from. It's completely driven by the psychology of customers and their behavior in times of tightening supply. That is what drives the overshoots in inventory and capacity."

If you still want to buy a chip fund, you do have a few fantastic choices.

Fidelity Select Electronics has been around since 1985 and is one of the oldest tech funds. This $10.8 billion fund invests primarily in semiconductor stocks, and had names like

Motorola

(MOT)

and Altera in its top holdings at the end of last year.

Fidelity's Select funds are known for their frequent manager changes, and this fund's leader, Brian Hanson, has only been at the wheel since Feb. 1. Nevertheless, the fund's 10-year record is striking. Its average annual return over that period through March 31 is an unbelievable 40.2%, ranking ahead of 99% of its peers, according to

Morningstar

.

The returns on the Firsthand Technology Value fund are just as imposing. Its five-year annualized return of 59.4% puts the fund above 99% of other tech funds.

Manager Kevin Landis has a well-documented penchant for semiconductor companies. He has owned PMC Sierra and

Applied Micro Circuits

(AMCC)

for years. At the end of last year, the fund had 37% of its assets in semiconductor and chip-equipment stocks.

The numbers are astounding but these funds are volatile like the chip stocks themselves. Both Select Electronics and Firsthand Tech Value have high standard deviations (a measure of how much a fund's return fluctuates), when compared to other tech funds.

You can also find heavy chip exposure in broader growth funds that are know for tech, like David Alger's funds. Also, the

(BRWIX) - Get Report

Brandywine and

(BLUEX) - Get Report

Brandywine Blue funds each had more than 20% of their assets in chipmakers and semiconductor-related stocks at the end of March. Top holdings in both were AMD and

Atmel

(ATML)

.

Chip HOLDRs Coming

If you're able to stomach the risk and you want a pure chip investment, consider the upcoming Semiconductor HOLDRs from Merrill.

HOLDRs are baskets of 20 stocks that are bought and sold as a single security and are traded on the

American Stock Exchange

. These 20 names in the proposed chip HOLDRs are considered to be the largest, most-liquid companies involved in the semiconductor business as measured by market capitalization and trading volume. You can only buy HOLDRs in 100-share lots.

The chip HOLDRs will be the ninth basket in the product line.

Broadband HOLDRs

(BDH)

, which raised over $550 million in investment before its launch, just

started trading last week.

The Semiconductor HOLDRs will trade under the symbol SMH. No word yet, though, on when they'll launch. For the first time, another broker,

A.G. Edwards

, is part of the underwriting. That means A.G. Edwards customers should be able to buy shares before they start trading in the open market. (But you can avoid the underwriting fee by waiting to buy in the aftermarket.)

The 20 stocks are right here:

So there you go. You should be prepared for a chip-dominated fund to have a few great years and then a few bad years, following the cycles of the sector itself. But think about what you might get if you can stick with one of these funds.

Quiz Fizzles

My apologies to all of you who tried to take yesterday's Jump$tart financial literacy quiz but couldn't submit your results.

Needless to say,

TSC

was experiencing technical difficulties with its polling system.

Tomorrow, I will print the survey along with the right answers. Plus, I will include the results from those of you who could vote. I hope that makes up for some of the frustration.

Send your questions and comments to

deardagen@thestreet.com, and please include your full name.

Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.