For the first time, uniform distribution of surface functionalized carbon nanofibers (CNFs) has been achieved in low molecular weight (≈120,000 g/mol) textile grade-polyacrylonitrile (PAN)-based composite filaments. Surface grafting of CNFs with acrylonitrile enhances the dispersion of nanofibers in PAN fiber matrix. XPS study reveals high atomic nitrogen content (7%) on the CNF surface due to the grafting reaction. The solution-spun filaments have been characterized for distribution of CNFs in the PAN matrix by electron microscopy. PAN composite filaments containing 3.2 wt.% CNF and processed at draw ratio of ≈6.3 exhibit enhanced tensile strength and modulus by more than three folds compared to the control PAN filament. Because of chemically compatible surface modification of the nanofibers, better dispersion and improved mechanical properties were accomplished in the reinforced PAN fibers. This should allow the production of CNF reinforced carbon fibers with improved tensile properties. An increase in CNF loading (6.4 wt.%), however, reduced performance due to inefficient alignment of CNF along the fiber axis. Nevertheless, hot stretching (at draw ratio ≈ 10) of the filaments enhanced tensile strength and elastic modulus of PAN composite filaments by 20–30% compared to the control hot stretched PAN filaments.