The aging populations in developed countries may make investing in the health-care sector seem like a no-brainer. But uncertain economic forecasts make it difficult to say exactly where that sector — and the mutual funds that invest in the makers and distributors of pharmaceuticals, and in medical equipment developers — are headed.

An important question, says Kris Jenner, vice president of T. Rowe Price Group Inc. in Baltimore and portfolio manager for TD Health Sciences Fund, is: who is paying for these services?

In developed countries, it’s the governments that largely foot the bill — and that can be a problem, says Lambros Piscopos, senior vice president, global equities, with Montreal-based Natcan Investment Management Inc. and portfolio manager of Altamira Health Sciences Fund. Governments account for 75% of health-care purchases, he says, but budget deficits and the global economic slump mean the money might not be as readily available as it has been. So, governments may try to use their buying power to negotiate lower prices or cut access to certain services and treatments. If that happens, it could be a negative for the health-care sector.

Another issue for the health-care sector is the “patent cliff” — the anticipated expiry in 2011 and 2012 of a great number of drug patents owned by pharmaceutical giants such as Pfizer Inc. Once a patent expires, generic-drug companies can duplicate the product and sell it for a fraction of its original cost.

Jenner believes, however, the market already has factored in the patent cliff, leading to lower-priced stocks: “The market is increasingly focused on what the earnings power of these companies are beyond [the patent cliff].”

How you view that potential for earnings depends on whether you see the research-and-development glass as being half-full or half-empty. Jenner believes increasing innovation in finding new treatments is creating many opportunities for both pharmaceutical firms and investors.

Piscopos, on the other hand, sees the escalating costs of drug development and the growing sophistication and strength of the generic-drug industry as risks. For example, because the health-care sector remains dominated by large-cap companies such as Pfizer and Johnson & Johnson Services Inc., the problem is that many of these firms can no longer produce new drugs fast enough to replace those with expiring patents.

The cost to develop drugs also is increasing because of stricter regulations by the U.S. Food and Drug Administration, which many regulators around the world follow, says Piscopos. As a result, drug firms must now do more drug trials with larger test pools, all while fewer drugs are being approved.

As well, Piscopos says, the generic-drug industry is becoming better capitalized and more sophisticated. For example, Israel-based Teva Pharmaceuticals Industries Ltd., a generic-drug firm that is challenging large-cap patents directly, “has a massive legal staff,” he says. “It’s able to fight the large-cap pharmaceutical [firms], challenge the patents and win those cases.”

In addition, generic-drug firms are now able to copy virtually any product created by a larger counterpart. “There’s nothing they can’t copy anymore,” Piscopos says. “There’s no such thing as something that’s too complicated.”

Despite these worries, health-care mutual funds still can have a place within a diversified portfolio. For fund portfolio managers, it’s all a matter of finding well-priced firms that can sidestep the risks.

Jenner and his team always look for firms that are bringing out important new medicines and have a history of innovation or breakthroughs in the health-care sector. As well, Jenner’s team tends to prefer smaller companies developing important medicines or medical devices that will have a substantial impact.

Piscopos points to Irvine, Calif.-based Allergan Inc., a small specialty firm best known for Botox. In addition to Botox’s cosmetic applications, the treatment has recently been approved for migraines. This is significant, Piscopos says, because “migraines are just an unmet medical need.”

As well, 60% of Allergan’s earnings come from patients’ own funds, not drug plans, Piscopos says, which means the firm is not as dependent on public funds. IE