Biotechnology exchange traded funds have reaped the performance benefits of merger and acquisition activity and the so-called patent cliff. This sector has produced some of the best-performing ETFs in 2012.

“The past few years were particularly tough for small- and mid-cap biotechs. The unprofitable ones were trapped: They needed to burn cash, push their pipelines forward, and attract partners, but the debt and equity markets were essentially closed for business. Not surprisingly, merger activity has heated up in the biotech industry, providing another potential catalyst for investors,” Robert Goldsborough wrote for Morningstar.

The potential for biotechnology to continue outperforming into 2013 is high. The generic competition is heating up putting the pressure on big pharma to find the best merges and acquisitions. Within the next few years, if Medicaid starts to cover more people, volume will be boosted for the drug industry. Morningstar believes this sector to be less vulnerable to government intervention than other healthcare sub-sectors. [More M&A Deals Could Boost Biotech ETFs]

The sector as a whole has been one of the best-performing in 2012. The Market Vectors Biotech ETF (NYSEArca: BBH) gained 61% this year. The index tracks companies that create treatments for health conditions. 25 of the largest, publicly traded biotech firms are represented, with Amgen, Gilead, and Biogen top holdings. The SPDR S&P Biotech ETF (NYSEArca: XBI) has gained 467% year-to-date. This ETF equally-weights 50 companies, taking on a completely different approach.[Biotech ETFs Hold Up During Rocky November]

The iShares Nasdaq Biotechnology ETF (NYSEArca: IBB) has gained about 44% this year. A history of five years with a cumulative return of 60% makes it hard to deny this ETF. Similar to BBH, IBB tracks large-cap biotech and pharmaceutical companies.[Election Could Make or Break Healthcare ETFs]