The emerging-market crisis and the turmoil in global stock markets are spilling over into hedge funds, as evidenced by the poor hedge fund-performance numbers for May that were released today.

The

Credit Suisse

(CSR)

/Tremont Hedge Fund Index, which mimics the returns of 421 funds, is a negative 1.30% in May, the first time this year that the index has posted a negative monthly return. For the year, though, performance remains positive at 6.40%.

The Barclay Group, a Fairfield, Iowa-based hedge fund index provider, estimates that more than 70% of hedge funds lost money last month. It reports that the average loss was 3.09%. Overall, the Barclay Hedge Fund Index that tracks the performance of more than 4,700 hedge funds posted a negative 1.78% return last month.

The riskier strategies that often give hedge funds an investment edge appear to have weighed heavily on their returns. "With signs that the

Federal Reserve

would raise interest rates to contain inflation, emerging markets suffered as investors shunned riskier investments resulting in the worst decline of emerging-market assets since 1998," says Robert Schulman, chief executive of Tremont Capital Management, a Rye, N.Y.-based hedge fund-asset management firm.

Not surprisingly, the hedge fund strategy that performed the worst last month was emerging markets, which posted a negative performance of 5.02%, according to the Credit Suisse/Tremont Index. The second poorest strategy was long/short equity (-2.84%), as many hedge fund managers have significant positions in emerging markets, as well as long exposure to equities.

"Long/short equity managers with large net and gross exposure were caught by the first sign of market uncertainty in two years," said Oliver Schupp, president of the Credit Suisse/Tremont Hedge Fund Index.

Since May 10, stocks have plummeted worldwide from the fear of further tightening policies by central banks and inflation worries. In the U.S., the fear of the Federal Reserve being tough on inflation has led to a sharp decline in stock prices over the past month and a half. The

S&P 500

was down 1.46% as of yesterday's close. Things started to improve Wednesday though, with stocks rallying for two consecutive days. Today, the S&P 500 rose 24 points, or 2%, to 1254. But nobody knows if the rally will be long-lived at this juncture.

"Equity strategies took the brunt of the losses, reflecting price declines in the stock markets of industrialized and emerging economies," says Sol Waksman, president and founder of The Barclay Group. In May, 11 of Barclay's hedge fund indices lost value. The Emerging Markets Index dropped 4.73%, Technology fell 3.44%, European Equities lost 3.37% and the Pacific Rim Index was down 3.24%.

Another hedge fund sector that has been hit hard, according to Credit Suisse/Tremont subindices, is managed futures, a sector that took a 2.70% loss last month. That is due to the meltdown in the global commodity market with gold, silver and copper trading downward. Managers in the managed futures space also were hurt by the strengthening of the dollar last month that caught them off guard, says a Credit Suisse/Tremont analyst.

The big winners were the short-sellers who took advantage of the downward market to post a positive performance of 5.39% for May, according to the Credit Suisse/Tremont Hedge Fund Index. Convertible arbitrage profited from a higher volatility with a 0.76% performance. Year to date, convertible arbitrage is up 7.11%, outperforming the overall hedge fund index, a sign that this sector is recovering from its loss of 2.55% last year. The return of volatility is good for convertible arbitragers who buy convertible bonds and hedge their purchases by selling the underlying stock.

Bad performance for hedge funds often means that managers lose a great deal of revenue because the bulk of their compensation comes from performance fees, which typically represent up to 20% of their gains. In addition, if investors redeem money, hedge fund managers lose in management fees as well, as those typically represent 1% or 2% of the assets under management.

In the face of adversity, some among the breed of small hedge fund players may find it compelling to shut down operations, waiting for better days to come, at which point they may reopen under a new business name. Such a pattern is not unusual in the hedge fund space and represents one of the most daunting risks incurred by hedge fund investors.

The poor performance in May could open the way for a new wave of hedge fund liquidations. At a news conference Tuesday, Tanya Beder, chief executive of Tribeca Global Management, part of

Citigroup

(C) - Get Report

, said that the task of retaining investors through consistent returns is particularly challenging for the smaller funds. She expects to see several thousand of them closing over the next few years.