That is how I always use iTunes, since the music was stored on my NAS. There is/was no requirement for iTunes to manage the storage and filesystem organization of your music - that was just the default.
The problem wasn't really at the iTunes end, that's just a symptom. It was at the iPod end. You'd go to a friends house and want to copy a few songs over from a Windows box and couldn't do it without installing a hundred gig monstrosity.
