The Federal Reserve is widely expected to start lowering interest rates at its September meeting, and to keep gradually lowering them through at least the end of 2025. And there’s reason to believe this can be a positive catalyst for small-cap stocks, and for a few reasons.

For one thing, small-cap stocks tend to have higher leverage than their large-cap counterparts, on average. Falling rates lead to lower borrowing costs, which would benefit them. Small caps are also generally earlier-stage businesses, and are considered to be riskier by many investors, but as rates on risk-free assets like Treasury securities and CDs fall and money flows back into the stock market, they also tend to attract significant inflows.

Also, there is a massive valuation gap between small-cap and large-cap stocks as a whole. The average price-to-book valuation of a stock in the S&P 500 index (large caps) is 4.7. For small caps, it’s 2.0. This gap hasn’t been as wide in about 25 years, and there’s a solid argument to be made that small caps are simply undervalued as a group right now.

And you don’t need to select individual small-cap stocks. There are some excellent small-cap index funds that can get you broad exposure to the space, including some from low-cost index fund provider Vanguard. Two are the Vanguard Small-Cap ETF (VB -0.34%) and the Vanguard Russell 2000 ETF (VTWO -0.75%). And while both can be great ways to play the small-cap tailwinds in the market, there are some differences to know about.

Two solid small-cap ETFs

Let’s start with the Vanguard Small-Cap ETF. This fund tracks an index of about 1,400 small-cap stocks. The median market cap in the index is $7.5 billion, and although it is a weighted index, no stock makes up more than 0.5% of fund assets.

On the other hand, the Vanguard Russell 2000 ETF tracks the prominent Russell 2000 small-cap index, which consists of 2,000 companies. Companies in this fund skew a little smaller than those in the Vanguard Small-Cap ETF, with a median market cap of $3.1 billion. They are also more undervalued as a group. Stocks in the Russell 2000 have a median 2.0 price-to-book multiple, compared to 2.4 for the other small-cap ETF in this discussion. No stock in the Russell 2000 accounts for more than 0.41% of assets.

Another notable difference is expenses. To be clear, both of these are low-cost index funds. However, the Vanguard Small-Cap ETF has an expense ratio of just 0.05%, compared with 0.10% for the Russell 2000 ETF. Now, a 0.10% expense ratio is still very low, and this shouldn’t necessarily be a deciding factor, but it’s important to know as you’re weighing the pros and cons.

The bottom line

These are two excellent small-cap ETFs, and for investors who want small-cap exposure in their portfolios, I don’t necessarily think either of them is a bad choice. Having said that, I slightly prefer (and own in my portfolio) the Russell 2000 ETF, mainly for its wider valuation gap compared to large caps and the added diversification of 2,000 stocks versus 1,400. But there is a solid case to be made in either direction.