Knowledge of the nature of molecular processes occurring during melt compounding of nanomaterials and polymers is crucial in determining the ultimate performance of polymer nanocomposites. In this paper, we demonstrate for the first time with detailed transmission electron microscopy, the parameters that affect the microstructure of polymer nanocomposites by varying the blending sequence. Nylon 66/organoclay/SEBS-g-MA ternary nanocomposites prepared by four different blending sequences exhibited distinct microstructure and mechanical properties. It was concluded that the best microstructure for toughness and other mechanical properties is to have the maximum percentage of the exfoliated organoclay in the nylon 66 matrix rather than to have it in the dispersed SEBS-g-MA phase. The presence of organoclay in the SEBS-g-MA phase reduces the latter's ability to cavitate, resulting in reduced toughening efficiency. (c) 2005 Elsevier Ltd. All rights reserved.