I think you raise a few good issues but I'd like to poke, lightly, at the idea that the only information advantage available to hedge funds is "insider" information. Certainly some successful firms built their track record with illegal insider trading that but that's not the whole story.

They have better access to research, they have better access to the analysts whose opinions help drive public understanding of the company, they have better access to management to ask clarifying questions on areas of concern. They spend every day steeped in the facts, perceptions, and research that are relevant to investing. In short, they have a massive information advantage over a casual investor or day-trader. This does not, necessarily, mean they're trading on "insider information."

Finally, just to clarify, insider trading is often misunderstood. A violation depends on meeting all of the following criteria:

1) The information is material. 2) The information is non-public. 3) There was a breach of duty in sharing or trading on the information.

As an oversimplification: if Joe overhears a conversation between the CFO of a Fortune500 company and his boss talking about losing a major contract... only the first two criteria are satisfied and Joe can buy/trade without fear of prosecution.