Published: Tuesday, 15 Sep 2009 | 10:48 AM ET

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One of Dubai’s most prominent investment funds is in talks with its bankers about refinancing its swollen debt burden after a steep fall in the value of its assets.

AP The Queen Elizabeth 2 was bought by Istithmar of Dubai.

Istithmar, the investment arm of the government-owned Dubai World conglomerate, has frozen its investment activity and laid off about 20 percent of its staff as it struggles to extract itself from a mountain of debt, according to a person briefed on its strategic plans. Analysts say the figure could well exceed $6 billion, a figure that in all likelihood is more than the equity value of the fund’s beaten-down investment portfolio.

The fund does not disclose its size, but as of April 2007, it had invested $3.5 billion. About $10 billion in debt was added — a valuation that represented a high point.

The fund’s predicament is an embarrassing turn of events for it, as well as for Istithmar’s chief executive, David Jackson. It also underscores the extent to which highly leveraged companies, as well as countries, remain at risk despite the recent recovery in world markets.

Set up in 2003, Istithmar came to be seen as the public face of a brash, acquisitive Dubai, which, unlike more conservative sovereign funds operating in the region, deployed high levels of leverage to finance a shopping spree that included the Queen Elizabeth 2 luxury liner; the department store Barneys New York; a stake in Cirque du Soleil, from Montreal; as well as luxury hotels in New York like the W on Union Square and the Mandarin Oriental on Columbus Circle.

Most of these investments — including that in Perella Weinberg Partners, the investment boutique, and GLG Partners, the asset management company — were done at the top of the market, from 2005 to 2007.

Istithmar was in many respects a scaled-down version of Dubai — using bravado, debt and some dollops of cash to invest in global markets. That approach ended sharply with the onset of the credit crisis. Dubai World, which owns Istithmar as well as its sibling real estate company, Nakheel, has about $60 billion in debt, according to public filings, a figure that approaches the overall leverage of Dubai itself, which Moody’s has estimated to be about $80 billion.

“These companies have invested heavily when valuations were very high, and they took on short-term debt to finance them,” said Philipp Lotter, a Middle East analyst at Moody’s. “They now find themselves in a situation after deterioration in their stakes where they need to refinance. It is an explosive combination.”

And while there has been speculation about the job security of Mr. Jackson, especially in light of the recent departures of two senior executives at the company, Dubai World has said recently that his position is not under threat.

“I continue to have the backing of Dubai World,” Mr. Jackson said in an interview. “And I am enthusiastic about our prospects. We will live to fight another day.”

The extent to which Mr. Jackson lives up to his boast will depend upon whether banks agree to length the payment terms on Istithmar’s debt burden and a sharp recovery in asset prices. Neither of these assumptions is a given: Barneys New York remains in financial trouble, and the recession’s toll has had its effect on Istithmar’s other luxury properties. These aspects of the situation generally do not put capital-constrained banks in a forgiving mood.

Still, analysts and investors in the region do not expect Istithmar to have to go through anything close to a default or a public restructuring, in light of the ignominy such an outcome would bring to Dubai and its ruler, Sheik Mohammed bin Rashid al-Maktoum.

“This is likely to be taken care of outside the public eye,” Mr. Lotter said.

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