Poor drug encapsulation efficiency and rapid release of the encapsulated drug limit the use of nanoparticles in biomedical applications involving water-soluble drugs. We have developed a novel polymer-surfactant nanoparticle formulation, using the anionic surfactant Aerosol OT (AOT) and polysaccharide polymer alginate, for sustained release of water-soluble drugs. Particle size of nanoparticles, as determined by atomic force microscopy and transmission electron microscopy, was in the range of 40-70 nm. Weakly basic molecules like methylene blue, doxorubicin, rhodamine, verapamil, and clonidine could be encapsulated efficiently in AOT-alginate nanoparticles. In vitro release studies with basic drug molecules indicate that nanoparticles released 60-70% of the encapsulated drug over 4 weeks, with near zero-order release during the first 15 days. Studies with anionic drug molecules demonstrate poorer drug encapsulation efficiency and more rapid drug release than those observed with basic drugs. Further studies investigating the effect of sodium concentration in the release medium and the charge of the drug suggest that calcium-sodium exchange between nanoparticle matrix and release medium and electrostatic interaction between drug and nanoparticle matrix are important determinants of drug release. In conclusion, we have formulated a novel surfactant-polymer drug delivery carrier demonstrating sustained release of water-soluble drugs.