Dynamic Fragmentation will automatically fragment a frame that is being sent to a host that will not accept a packet size 1500. Such as those using DSL connections. I personally I don't use it since I'm on Cable.
It's not the same as the fragmentation threshold adjustment in wireless devices. In wireless, lowering the fragmentation threshold lowers the maximum frame size a device can transmit without fragmenting the frame. Which is suppose to reduce collisions which in turn will reduce the number of retransmissions.
If your asking if it will limit the lag that your xbox will encounter, I don't think so, since the XBL servers are more in control of that and what people do on there xboxes and what;s all connected in between. Lag is probably always going to rear it's ugly head when it's not needed.
The only thing you can do is to make sure is that your network is setup and configured well, in house, out to your ISP. I also bought my own CABLE modem, there are better ones available then some of the default ones they have you rent. Same for DSL modems too.
My 2 cents.