I was the one giving you the earlier answer and you're thinking about this the wrong way. The /f flag doesn't affect how a space is handled but how paths are handled.
If you run xcopy without the /f flag you can see that it works on the files relative to the working directory or the paths you've given. Apparently this is also used by the internal logic of xcopy so when you run it by default it can only filter on the parts of the path you've specified in the copy command.
When you add the /f flag xcopy will display the full path of the file irregardless of how you invoked the copy. Since this seem to affect the internal logic this also makes it possible to filter on the full path of the file and not just the relative paths.
This is not explained in the current documentation of xcopy which leads you to believe that it only affects the display and not the internal logic.
You can test this for yourself with the following.
Create a folder c:\unicorns and a folder c:\ponys
In the unicorns folder, create three files: test1.txt, test2.txt and exclude.txt
Edit exclude.txt and paste the following
Go to c:\unicorns and run the command
xcopy *.txt ..\ponys /exclude:exclude.txt
You'll see that it copies test2.txt and exclude.txt
Now add the /f flag as follows
xcopy /f *.txt ..\ponys /exclude:exclude.txt
You'll notice that it only copies exclude.txt this time.
In this example our working directory was c:\unicorns and thus the names displayed only contained the filenames.
We can continue with this and show what happens if you use absolute paths. Use the same setup of directories as before and run the command
xcopy c:\unicorns\*.txt c:\ponys /exclude:c:\unicorns\exclude.txt
Now you can see that the only file copied is exclude.txt. By giving the absolute paths i the command, they're used in the internal logic and can be filtered upon.
If you try this with the /f flag you will notice that they work the same
xcopy /f c:\unicorns\*.txt c:\ponys /exclude:c:\unicorns\exclude.txt
I hope this gives a clear explanation of how it currently works.