As our population continues to grow and age, finding proper healthcare solutions will remain a top concern. Overall, Americans during the second half of this decade have spent nearly trillions on healthcare and that number continues to rise. A similar story is occurring in the developing world. As rising incomes and the new middle class crave many of the same "luxuries" as the west, healthcare spending by these nations will also rise. However, while much of investor attention in the sector has gone towards the major pharmaceutical companies or funds like iShares Dow Jones US Pharmaceuticals (NYSE:IHE), that may not be the best choice. With the "Age of the Blockbuster" coming to an end, big pharma must reposition itself. For investors, that could lead to gains.

TUTORIAL: Retirement Planning

Higher R&D Spending
The major pharmaceutical companies are staring down the barrel of gun. Billions of dollars worth of patented, protected drugs are expected to go generic over the next few years. In 2012 alone, more than billions worth of drugs will lose their patents including Singulair, Viagra and the Sanofi-Aventis (NYSE:SNY) and Bristol-Myers Squibb (NYSE:BMY) gigantic success Plavix. However, in the face of this problem, the majors continue to cut costs, specifically in research and development. For example, GlaxoSmithKline (NYSE:GSK) has extensively cut its R&D costs by closing research facilities and doing less discovery work in-house.

The task of drug innovation has fallen to the biotech sector. Overall R&D expenditures for smaller biotech firms as a percentage of revenue are roughly 108%, versus the 54% for larger firms. Some analysts also estimate that by 2014, biotech drugs will account for almost 50% of the top 100 drugs. This compares to just 28% in 2008 and only 11% in 2000. With some biotech treatments for rare diseases costing thousands, big pharma has been taking notice of biotech's potential. Partnerships between the sectors are on the rise, and more recently acquisition activity has picked. Sanofi's purchase of Genzyme was just the tip of the iceberg. More recently, Israel's Teva Pharmaceuticals (Nasdaq:TEVA) agreed to purchase Cephalon (Nasdaq:CEPH) for $6.2 billion. There is a general need for drugs that treat diseases such as diabetes, hepatitis C, and cancer that have high current demand and favorable demographic trends. With the biotech industry focusing on rare diseases and antibodies, will suit it well going forward.

Healthcare Lotto Tickets
Historically, biotech investing has been described like playing the lottery. Generally, companies within the sector are small labs with just one drug under their belts and the vast numbers of them fail. These companies rise and fall with each round of FDA testing. For investors, Betting on a basket of these companies may be best. Both the SPDR S&P Biotech (NYSE:XBI) and iShares Nasdaq Biotechnology (NYSE:IBB) allow investors to add a wide swath of the industry to a portfolio.

For those investors looking to play the lotto aspect of biotech, Aeterna Zentaris (Nasdaq:AEZS) could be a good bet. The company has a rich pipeline of biotech drugs and its colorectal cancer treatment has entered late stage phase 3 trials. Similarly, small biotech Zalicus (Nasdaq:ZLCS) quality drug pipeline has analysts at Oppenheimer upping the company's share price target to $4.

Finally, for those who wish to play the take-over angle, analysts at Morningstar see Biogen (Nasdaq:BIIB), Seattle Genetics (Nasdaq:SGEN) and BioMarin (Nasdaq:BMRN) as possible acquisition targets from big pharma. These firms have strong pipelines as well as variety of rare disease drugs that could supplement the major pharmaceuticals offerings.

The Bottom Line
In the wake of the big pharma's patent cliff and slowing R&D spending, the biotech sector is looking good for investors. As both the primary driver of new drug innovation as well as being a source of growth for the majors, biotech's dominance in healthcare is assured. For investors, adding a fund like the First Trust NYSE Arca Biotech Index (NYSE:FBT) could do portfolio wonders. (One program is for the poor; the other is for the elderly. Learn which is which. See What's The Difference Between Medicare And Medicaid?)

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