Do I need to defragment virtual hard disks on the host or the guest server to improve performance, or both?
This depends on how you have things configured. A virtual hard disk file can get fragmented like any other file, so the best tactic is to not have to defragment it. If you are using a virtual hard disk file for the guest operating system, defragment the system first before creating it so you won't have to defragment the file itself later. However, if you're dedicating an entire physical drive or partition to a given virtual operating system -- which is the best option as far as performance goes -- then all the defragmentation will take place inside the virtual operating system itself.
If you link a virtual disk to a physical disk, this will improve performance and will also eliminate any problems with the virtual hard disk file growing fragmented. You will still need to perform any needed defragmentation on the guest operating system's hard disk from within the guest operating system though.
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