Biotech stocks have been outperforming the broader market over the past three months, driven by optimism regarding potential rate cuts. The Fed is expected to start cutting rates later this month, and traders anticipate a total of 100 basis points in rate cuts by the end of the year.

Many smaller biotech companies are unprofitable and rely on debt to fund their research. A lower cost of capital generally results in better performance for the sector.

Additionally, big pharma’s willingness to pursue deals increases with declining interest rates. With record levels of cash on their balance sheets, these pharmaceutical companies are looking to acquire small, innovative firms to boost their pipelines.

At the same time, the sector is experiencing unprecedented innovation in multiple areas, including treatments for obesity and cancer, as well as advancements in gene editing.

The SPDR S&P Biotech ETF (XBI Quick QuoteXBI - Free Report) , the most popular product in the space, tracks an equal-weighted index and is therefore tilted towards smaller companies.

The iShares Biotechnology ETF (IBB Quick QuoteIBB - Free Report) tracks a market-cap-weighted index, with Gilead Sciences (GILD Quick QuoteGILD - Free Report) and Regeneron Pharmaceuticals (REGN Quick QuoteREGN - Free Report) as the top holdings.

The ALPS Medical Breakthroughs ETF (SBIO Quick QuoteSBIO - Free Report) focuses on innovative small- and mid-cap biotech companies.

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