NEW YORK (CNNMoney.com) - Hedge funds took it on the chin during the recent market correction, owing to sharp declines in metal prices and drops in the broader stock markets.

After two consecutive weeks of strength in the beginning of May, hedge funds, which are lightly regulated investment pools for wealthy individuals or institutional investors, fell sharply in the third week. The Merrill Lynch Diversified Hedge Fund Index ultimately posted a 0.94 percent loss for the first three weeks, the most recent available, according to an analyst note from Merrill Lynch.

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Hedge funds use a variety of strategies, from betting on or against stocks, currencies or commodities to more esoteric strategies involving "derivative" investments or turning around distressed companies.

All but two of the hedge fund strategies Merrill Lynch tracks were in negative territory for the first three weeks of May.

"There weren't many places to hide," said Philippe Bonnefoy, investment adviser to Cedar Partners, the research affiliate of Comas Management.

But Bonnefoy noted that up to the middle of May, hedge funds had performed strongly in 2006. Hedge funds were up 8.1 percent for the year through April, according to Hedge Fund Research (HFR).

"We had an amazing first quarter, so I think the dreadful performance in May has to be put in perspective," said Bonnefoy.

Bonnefoy noted that emerging markets funds struggled particularly hard. Among the factors: Stocks in India posted their largest-ever decline, with the Bombay Stock Exchange Ltd. and National Stock Exchange suspending trading for an hour after the market fell more than 10 percent at one point, according to Reuters.

Bonnefoy said that while emerging markets funds had a great first four months thanks to big gains in Russia, India, China and Brazil, many lost about half their gains for the year due to the May correction. HFR's global emerging markets index was up 9.8 percent through the end of April.

Managed futures funds, which trade commodity futures contracts, also fell hard last week, declining 3.2 percent in the week ending May 22, owing in part to a sharp drop in precious metals prices following a sell off as well as a pullback in energy. Managed futures funds lost 2.1 percent for the first three weeks of May.

Larry Smith, chief investment officer of global macro investment advisor Third Wave Global Investors, said the metals sell off was partly fueled by hedge funds that had been investing in those markets more aggressively than normal, making them quick to get out once the market started to decline.

Bonnefoy thinks that many commodities-focused funds lost between 10 percent and 20 percent for all of May. But some of those funds had been up as much as 50 percent for the year before mid-May.

U.S. equity long/short funds, which hold long positions in stocks and hedge those positions by shorting stocks, ETFs or related instruments, fell 2.7 percent during the third week, and 3.5 percent for the first three.

"If you take a look at world's equity markets, you know it was difficult," said Third Wave's Smith. "U.S. equity markets were down 3 percent; foreign markets were down a lot more."

The Merrill Lynch analysts also blame new Federal Reserve Chairman Ben Bernanke - not because of his policies, but because the first year for any new Fed chairman means higher volatility and lower equity returns for the S&P 500, according to the analysts.

Equity markets proved choppy in May in part because of economic data, added Smith. "Investors overreacted to small surprises in economic data," said Smith, referring specifically to the Labor Department's Consumer Price Index, or CPI, the government's main inflation gauge. The CPI jump was minor, but nevertheless re-ignited fears of inflation and sparked a sell off in stocks.

Global macro funds, which invest in currencies and other instruments in foreign markets, fell 2.8 during the third week and 2.7 percent for the first three.

These early summer doldrums fall on the heels of a strong first quarter for hedge funds, which posted their best first quarter in three years at the start of 2006 and pulled in $24 billion in new assets.

Smith said he believes the markets will suffer from jitters for the next month or two, but he does not believe this is the beginning of a protracted bear market.

"We'll look back on this as a period of time when investors overreacted to concerns that the central banks of the world would make a policy error," said Smith.

Hedge funds worldwide manage an estimated $1.2 trillion, according to HFR.

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