Regional central banks and major institutional investors are aware of such limitations; hence the best way forward is to complement rating-embedded investment guidelines with a more robust and rigorous internal credit risk evaluation framework. In tandem with diversification into alternative asset classes, there is a growing emphasis to improve the sophistication of risk modelling, taking into account how risk can be initially understated when herding behaviour dominates, but rears its ugly head during reversals. iv)  The growing importance of Islamic finance  As events unfolded in the midst of the financial crisis, the sustained expansion of global growth and development in Islamic finance has emerged as one of the most prominent trends in global financial landscape. The industry continues to draw significant interests from all corners of the world. The global financial crisis underscores the potential role and relevance of Islamic finance as a viable approach in investing. Due to the Shariah prohibition of excessive leverage and unproductive cash hoarding, Shariah-compliant funds have outperformed their conventional peers since the onset of the crisis. As a result, there has been greater appreciation of the principles of Islamic finance, as evidenced by the expansion of interest and demand for Islamic financial products on a global scale. In line with the rapid growth of Islamic finance, emphasis has been placed on the development of the international financial infrastructure such as setting prudential standards and international best practices, a role spearheaded by the Islamic Financial Services Board.

Contrary to the approach taken by many during the recent crisis, Malaysia had further liberalised the foreign exchange administration (FEA) rules in our efforts to promote efficiency, reduce costs and create a more conducive environment for trade, business and investment activities. The accomplishments in financial sector reforms and the many policy changes made have augured well for the country, as evident by our ascent into the top-20 bracket in the World Economic Forum’s financial development index this year. As with other countries within the region, we have also been a recipient of capital flows. As a result of continuous effort to strengthen the financial sector, our ability to manage the volatility and other impacts of capital flows has been enhanced. The financial markets and banking sector have proven their ability to absorb and intermediate these inflows while the Central Bank is always monitoring the market on a daily basis and is also well positioned to manage the situation. The domestic economy stands resilient and inflation remains under control. Furthermore, the pace of ringgit appreciation also reflected the positive underlying fundamentals of the economy. Trends of investing by central banks and institutional investors i)  The concept of diversification  Let me now share some thoughts on portfolio diversification. Nearly 60 years since the proposition of Modern Portfolio Theory by Harry Markowitz, many investors are still grappling with the challenges of portfolio diversification. Among the sands in the wheel of a welldiversified portfolio are transaction costs and information asymmetry.