President Obama’s health care reform may be controversial, but the health care sector has emerged as a top performer in 2011. The sector will likely continue to deliver tidy profits, particularly if investors avoid the industry’s usual suspects.

The landmark Patient Protection and Affordable Care Act (PPACA) passed in March 2010 after months of horse trading. Among the deals that were struck, medical device makers agreed to a new 2.3 percent tax on sales beginning in 2013. Meanwhile, clinical lab companies signed on to a 1.75 percent annual cut in Medicare reimbursements for the next five years, a move meant to stave off tighter regulation of the sector.

A glance at the top-line details of the plan reveals a number of headwinds for the health care industry. But after months of stasis, the sector has begun to gather momentum as analysts and industry watchers dig deeper into the legislation. For example, although device makers will face a new tax, loopholes in the legislation mean the new tax is also tax deductible. It’s a wash for the industry.

Laboratories will see their reimbursements cut. But a larger patient pool—the law is expected to create 32 million new health care consumers—should benefit many pharmaceutical outfits. Health insurers also stand to gain from an upsurge in government-mandated premiums paid into their plans.

Investors have come see the new legislation as a mixed bag and the health care sector has returned 2.3 percent year to date, compared to a 0.5 percent decline for the S&P 500. That’s because health care names have a lot to offer investors, from relatively stable earnings to attractive dividend yields. Meanwhile, valuations remain near all-time lows on a price-to-earnings basis, even as many health care companies cut costs aggressively to maintain margins.

Sell-side researchers at many of the major brokerage houses have also changed their tune. Analysts initially bemoaned the cost pressures associated with health care reform. Pharmaceutical companies, in particular, would likely suffer lower reimbursement rates on their drugs. However, as analysts have come to understand the nuances of PPACA, their focus has shifted to opportunities arising from the health care reform legislation.

An uptick in merger and acquisition (M&A) activity also should continue to push valuations higher in the pharmaceutical industry. Facing patent expirations and weak development pipelines, many large and midsize companies have addressed these long-term challenges by acquiring smaller companies with promising drugs that are near approval—a strategy that’s less risky and more cost-effective than relying solely on internal research and development. Although acquirers may overpay for assets, thus far the majority of deals have featured reasonable valuations.

Over the long term, global fundamentals—from aging populations in the developed world and rising household incomes in emerging markets—will drive growth for the health care industry. Low fertility rates and longer life expectancies mean that Europe’s population of people over 60 years old will grow by roughly 2 million individuals with each passing year. In the US, the leading edge of the baby boomers will enter retirement in 2011. As people grow older, they tend to consume more health care products and services.

Meanwhile, the United Nations reports that hospital construction accelerated by 30 percent over the past five years in Africa and by more than 20 percent in South America. All of those new hospitals have to be equipped—a boon for medical device and supply manufacturers, as well as mutual funds that invest in the industry.

T. Rowe Price Health Sciences (PRHSX) has returned 20.9 percent year to date, besting both the S&P 500 and 94 percent of its rivals in the health care specialty funds category.

The fund’s success stems from the deep know-how of manager Kris, Jenner, who is a doctor by training. Jenner’s portfolio has avoided many of the large-cap pharmaceutical names that face a wave of patent expirations in coming years. Instead, Jenner has loaded up on mid-cap companies, which represent 44 percent of the fund’s investable assets. Meanwhile a third of the fund’s portfolio is devoted to biotech stocks.

Jenner’s bets on smaller fry have vaulted the fund to the top 1 percent of its category on a one- and five-year basis; T. Rowe Price Health Sciences ranks in the top 14 percent on a three-year basis. The fund’s low 0.84 percent expense ratio also helps protect profits for this attractive long-term holding.