The main goal of this study was to investigate pancreatic islet function with mesenchymal stem cells (MSCs) in a ligand-functionalized poly(ethylene glycol) (PEG) hydrogel for the treatment of type 1 diabetes (T1D). Rat bone marrow-derived MSCs (rBM-MSCs) were encapsulated within synthetic PEG hydrogel, and cell viability and apoptosis within this 3D environment was examined in detail. ATP content and caspase-3 activity of encapsulated MSCs showed that fibronectin-derived RGDS, laminin-derived IKVAV and/or insulinotropic glucagon-like peptide (GLP-1) were required to maintain MSC survival. Incorporation of these peptides into the hydrogel environment also improved pancreatic islet viability, where combinations of peptides had altered effects on islet survival. GLP-1 alone was the leading stimulator for insulin secretion. Cell adhesion peptides RGDS and IKVAV improved insulin secretion only when theywere used in combination, but could not surpass the effect of GLP-1.Further, when pancreatic islets were co-encapsulated with MSCs within synthetic PEG hydrogel, a two- fold increase in the stimulation index wasmeasured. Synergistic effects ofMSCs and peptideswere observed, with a seven-fold increase in the stimulation index. The results are promising and suggest that simultaneous incorporation ofMSCs and ECM-derived peptides and/or GLP-1 can improve pancreatic islet function in response to altered glucose levels in the physiological environment. Copyright (C) 2014 John Wiley & Sons, Ltd.