The manual tries to explain what it does, but through experimenting I am not able to get any difference between having the preference on or off.
The manual says:
If this option is activated, the layering of MIDI instruments (by MIDI sends) is also active within the MIDI editors. This way, the acoustic feedback of the editors sends the MIDI data not only to the output selected for the track, but additionally through any MIDI inserts and MIDI sends assigned to it. However, this also means that MIDI events will be sent through any MIDI plug-ins assigned to this track.
I thought what that means is that if I’m using MIDI sends going to several instruments that when I open the midi clip in a midi editor that I will still be able to hear all the instruments. However I am indeed able to hear all the instruments regardless of it being on or off. Any ideas?