This is because the ReadXml method takes a string. That string must be the name of a file. It cannot be XML. If you pass it a string that is XML, it will think that is the name of the file! It doesn't have the smarts to look at the string and ask "Is this string XML, or is it a file name?" and figure that out.
// Summary:
// Reads XML schema and data into the System.Data.DataSet using the specified
// file.
//
// Parameters:
// fileName:
// The filename (including the path) from which to read.
public XmlReadMode ReadXml(string fileName);
By wrapping the XML in a stringreader or a stream or something, you are calling a different overload, that expects XML instead of a file name.