Bone marrow derived mesenchymal stem cell (BMSCs) therapy can significantly improve cardiac ventricular function following ischemic injury. Their potential can be further enhanced by using genetically modified cells, overexpressing certain therapeutic biomolecules. However, such therapy is limited by low efficiency of transplantation of the cells, secreting inadequate therapeutic proteins. To address these issues, we developed recombinant baculoviruses to genetically modify the BMSCs and investigated the potential of using polyethylene glycol (PEG) integrated alginate-chitosan microcapsules (AC) for efficient myocardial transplantation. The data indicates that the cells encapsulated in AC-PEG microcapsules grew rapidly from 80 cells per capsule to above 100 cells per capsule within a week, reaching a confluency of average 110 cells by day 9 of encapsulation. The microcapsules proved superior to commonly used AC microcapsules in terms of immune protection. After 11 days of co-culture of the encapsulated cells with highly confluent lymphocytes, the viable cell population in AC-PEG microcapsules was reduced by only 20%, whereas in AC microcapsules it was reduced to more than 50%. AC-PEG microcapsules also had significantly higher mechanical (65 vs. 10%) and osmotic (92 vs. 52%) stability than commonly used AC microcapsules as seen after 2 h of external stresses. The entrapped genetically modified cells showed highest transgene expression on day 1, which was gradually reduced to 48% after 1 week and to 14% after 2 weeks. This expression pattern was also dependant on initial viral incubation time, with 8 h incubation being the optimum. The encapsulated cells, transduced with baculovirus, also retained their inherent potential to differentiate into multiple lineages. Because of the above characteristics, the baculovirus transduced microencapsulated BMSCs have immense potential in myocardial cell-based gene therapy, although preclinical studies are needed to be done to establish their functional benefits on myocardial implantation.