As patent expirations and high-profile litigation weighed on the drug industry the past several years, the manufacture and marketing of pharmaceuticals has proved to be a pretty tough business. In fact, last year, the sector lagged the S&P 500 by 4 percentage points and was one of the weakest performers within the healthcare space.

That said, I expect 2013 will be a good year for the pharmaceutical industry as a result of several factors.

Last year, drug patent expirations impacted a total of $52 billion in branded-drug sales worldwide. This year, that total falls to around $25 billion, its lowest level in recent years.

Some of the biggest expirations to watch out for are the antidepressant Cymbalta (June, $2.8 billion in 2011 sales) and insulin analog Humalog (May, $1.2 billion) at Eli Lilly & Co (NYSE: LLY), the bone cancer treatment Zometa (March, $700 million) at Novartis (NYSE: NVS), and cholesterol drug Niaspan (September, $900 million) at Abbott Laboratories (NYSE: ABT).

A Surge in New Drug Approvals

As the industry hurtled over the so-called patent cliff last year, the Food and Drug Administration (FDA) went on an approvals spree, giving the green light to 39 new drugs in 2012. That was the largest number of drug approvals in the US since 1996, outpacing approvals in both Canada and Europe, where regulators tend to be less stringent.

However, that surge in approvals isn’t indicative of a kinder, gentler FDA.

For one thing, we’re seeing the benefit of the 1992 Prescription Drug User Fee Act (PDUFA), which empowers the FDA to charge a hefty application fee when drug companies submit a new drug application (NDA).

But rather than just dumping those fees into a general fund, the act requires the FDA to channel that money to the Center for Drug Evaluation and Research or the Center for Biologics Evaluation and Research, both of which are involved in evaluating NDAs. That policy incentivizes these entities to meet benchmarks related to speedy NDA reviews and decisions in order to collect the application fees.

According to data from the Government Accountability Office, thanks to the PDUFA the median approval time for new drugs has fallen from 27 months a decade ago to about 14 months today. Additionally, about 95 percent of NDA reviews are completed on time.

The timing of that improved FDA efficiency couldn’t have been more fortuitous.

Most of the major pharmaceutical companies began to recognize that they were facing a serious patent cliff in the mid-1990s. To dampen its effect, they began ramping up research and development, while also pursuing mergers and acquisitions (M&A) to pick up attractive compounds under development.

The wave of NDAs we’ve seen recently is largely the result of such strategic foresight.

We might have another year of high approvals in 2013, since the FDA approved 230 new molecular entities (NME) last year. NME approval of a compound paves the way for a pharmaceutical company to file an NDA and, in many cases, entitles that NDA to an expedited review process.

Emerging Market Demand

Another secular trend that will benefit pharmaceutical companies in 2013 and beyond is increased emerging market spending on drugs.

While the pace of growth in drug spending will likely slow over the next few years in the developed world due to cost-containment measures, growth in the emerging markets is expected to explode.

According to data from the IMS Institute for Healthcare Informatics, global drug spending totaled about $956 billion in 2011. It predicts that spending will jump to about $1.2 trillion by 2016.

Although most of the growth in drug spending over the past decade occurred in the more prosperous developed world, emerging markets will drive much of that growth going forward, accounting for about a third of global drug sales by 2016.

As the first world contends with sluggish economic growth, the developing world is seeing the emergence of a burgeoning middle class, with demand driven by growing populations with rising incomes. Although per capita drug spending in the emerging markets will probably be just a fraction of that of the developed world for decades to come, its larger populations mean that even a small bump in demand equates to a massive amount of new spending.

As such, the expected $6 billion pop in US drug spending expected in 2014 from the healthcare reform law’s individual mandate will look like chump change compared to the spending growth from countries such as China.

The Best ETF to Play These Trends

Pharmaceutical exchange-traded funds (ETF) are the easiest way to play these trends, given the broad diversity of their holdings and global reach. While there are several available, my favorite is SPDR S&P Pharmaceuticals (NYSE: XPH).

The fund’s portfolio of 30 names includes a substantial stake in large-cap (28.4 percent of assets) pharmaceutical companies, so they will help steady the fund’s performance. But it also has some of the largest allocations to mid-cap (35.1 percent) and small-cap (31.1 percent) stocks of any pharmaceutical ETF. As a result, it provides exposure to some of the best innovations in the industry, as well as the potential to benefit from any M&A activity.

And while all of its holdings are US-based companies, most of them have a significant presence overseas. Indeed, nearly half of all earnings generated by companies in the ETF’s portfolio are sourced internationally.

In addition to its attractive exposures, the fund also happens to be the cheapest pharmaceutical ETF available, with an annual expense ratio of just 0.35 percent.

What’s New

No new exchange-traded products were launched last week due to the New Year’s holiday.