debenture fundmiddlefield.com/pdf/path/report2012.pdf · initial public offering 1ryepber 2012...

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PATHFINDER CONVERTIBLE

DEBENTURE FUND

Annual Report 2012

(L-R) Jeremy Brasseur, Managing Director, Corporate Development, Nancy Tham, Managing Director, Sales and Marketing, Andy Nasr, Executive Director and Portfolio Manager, Rob Lauzon, Managing Director, Western Canada, Discovery Funds, Dean Orrico, President and CIO, Richard Faiella, Managing Director, International, and Dennis da Silva, Managing Director, Senior Portfolio Manager, MRF Funds

Performance. One Step at a Time.

CALGARY: 812 Memorial Drive NW, Calgary, Alberta T2N 3C8 TORONTO: First Canadian Place, 58th Floor, P.O. Box 192, Toronto, Ontario M5X 1A6 Toll Free: 1.888.890.1868 www.middlefield.com [email protected]

MIDDLEFIELD

March 2012Initial Public Offering

$61,200,000MIDDLEFIELD INCOME PLUS II CORP.

anage b Mi le el r u

Price: $12 per equity share

BMO CAPITALMARKETS

NATIONAL BANKFINANCIAL INC.

SCOTIABANK INC. TD SECURITIES INC.

CANACCORDGENUITY CORP.

GMPSECURITIES L.P.

MACQUARIE PRIVATEWEALTH INC.

RAYMONDJAMES LTD.

MIDDLEFIELD CAPITAL CORPORATION

DUNDEE SECURITIES LTD. MACKIE RESEARCH CAPITAL CORPORATION

CIBC WORLD MARKETS INC. RBC CAPITAL MARKETS

$60,000,000MRF 2012 RESOURCE LIMITED PARTNERSHIP


Price: $25 per unit

ril 2012Initial Public Offering

MACQUARIE PRIVATE WEALTH INC. MANULIFE SECURITIES INCORPORATED

CANACCORD GENUITY CORP. GMP SECURITIES L.P.

DUNDEE SECURITIES LTD. MIDDLEFIELD CAPITALCORPORATION

RAYMOND JAMES LTD.


BMO CAPITALMARKETS


SCOTIABANK TD SECURITIES INC.

Since its inception in 1979, the Middlefield Group, with over $3 billion in assets

under management, has established a strong reputation as a creator and manager

of unique investment products designed to balance risk and return to meet the

demanding requirements of investment advisors and their clients. These financial

products include Mutual Funds, Private and Public Resource Funds, Venture Capital

Assets, TSX Publicly Traded Funds and Real Estate Investment Partnerships.

#1 NEUTRAL BALANCED MUTUAL FUND OVER 3-YEARSMiddlefield Income Plus Class

#1 NEUTRAL BALANCED MUTUAL FUND OVER 10-YEARSMiddlefield Income Plus Class

#1 NATURAL RESOURCE EQUITY FUND OVER 1-YEARGroppe Tactical Energy Class

e ber 2012Initial Public Offering

$50,000,000DISCOVERY 2012 FLOW-THROUGH LIMITED PARTNERSHIP


Price: $25 per unit

BMO CAPITAL MARKETS NATIONAL BANK FINANCIAL INC. TD SECURITIES INC.SCOTIABANK


MIDDLEFIELD CAPITALCORPORATION

RAYMONDJAMES LTD.

MANULIFE SECURITIES INCORPORATED

GMP SECURITIES L.P. MACQUARIE PRIVATE WEALTH INC.

DUNDEE SECURITIES LTD.

RBC CAPITAL MARKETS CIBC WORLD MARKETS INC.

$75,000,000MIDDLEFIELD CAN-GLOBAL REIT INCOME FUND


Price: $10 per unit

e ber 2012Initial Public Offering


GMPSECURITIES L.P.

MACQUARIE PRIVATEWEALTH INC.

RAYMONDJAMES LTD.

MIDDLEFIELD CAPITAL CORPORATION

DUNDEE SECURITIES LTD. MACKIE RESEARCH CAPITAL CORPORATION


BMO CAPITALMARKETS


SCOTIABANK TD SECURITIES INC.

Oct ber 2012Treasury Offering

$40,000,000MIDDLEFIELD CANADIAN INCOME PCCanage by Mi le el Internati nal i ite

TRADES ON THE LONDON STOCK EXCHANGEUNDER THE SYMBOL MCT

CANACCORD GENUITY LIMITED

August 2012Treasury Offering

$43,031,700PATHFINDER CONVERTIBLE DEBENTURE FUND

anage by Mi le el r u

Price: $12.33 per unit

BMO CAPITALMARKETS


SCOTIABANK INC. TD SECURITIES INC.

MACQUARIE PRIVATE WEALTH INC.

CANACCORD GENUITY CORP.GMP SECURITIES L.P. MIDDLEFIELD CAPITAL

CORPORATIONRAYMOND JAMES LTD.

DUNDEE SECURITIES LTD.


MIDDLEFIELD Canadian Income PCC

A NOTE ON FORWARD LOOKING STATEMENTSThis document may contain forward looking statements, including statements regarding: the Fund, its strategies, goals and objectives; prospects; future performance or condition; possible future actions to be taken by the Fund; and the performance of investments, securities, issuers or industries in which the Fund may from time to time invest. Forward looking statements include statements that are predictive in nature, that depend upon or refer to future results, events, circumstances, expectations and performance, or that include words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “estimates” or negative versions thereof and other similar wording. Forward looking statements are not historical facts, but reflect the Fund’s current beliefs as of the date of this document regarding future results, events, circumstances, expectations or performance and are inherently subject to, among other things, risks, uncertainties and assumptions about the Fund and economic factors. Forward looking statements are not guarantees of future performance, and actual results, events, circumstances, expectations or performance could differ materially from those expressed or implied in any forward looking statements contained in this document. Factors which could cause actual results, events, circumstances, expectations or performance to differ materially from those expressed or implied in forward looking statements include, but are not limited to: general economic, political, market and business factors and conditions; commodity price fluctuations; interest and foreign exchange rate fluctuations; global equity and capital markets; the financial condition of each issuer in which the Fund invests; the effects of competition in the industries or geographic areas in which the Fund may invest; statutory and regulatory developments; unexpected judicial or regulatory proceedings; and catastrophic events. Readers are cautioned that the foregoing list of factors is not exhaustive and to avoid placing undue reliance on forward looking statements due to the inherent uncertainty of such statements. The Fund does not undertake, and specifically disclaims, any obligation to update or revise any forward looking statements, whether as a result of new information, future developments, or otherwise.

Middlefield CORPORATE PROFILE

Since its inception in 1979, the Middlefield Group, with

over $3 billion in assets under management, has established

a strong reputation as a creator and manager of unique

investment products designed to balance risk and return

to meet the demanding requirements of investment advisors

and their clients. These financial products include mutual

funds, real estate and closed-end, publicly traded income

funds as well as private and public resource funds and

venture capital assets.

Many of Middlefield’s investment products are designed

and managed by our own professionals while some involve

strategic partnerships with other “best-in-class” firms that

bring unique value to our product offerings. Our investment

team comprises portfolio managers, analysts and traders.

Guardian Capital LP, one of the pioneers in developing

income products, acts as Co-Advisor on several of our

income funds while Groppe, Long & Littell, based in Houston

and one of the world’s leading forecasters of oil and natural

gas prices, acts as Special Advisor with respect to the

strategic outlook for the energy sector.

Looking ahead, Middlefield remains committed to the

goal of developing new and unique investment products

to assist investment advisors in providing added value for

their clients.

TABLE OF CONTENTS

Corporate Profile

3 2012 Review and Outlook

Pathfinder Convertible Debenture Fund 5 Annual Management Report

of Fund Performance

10 Management’s Responsibility for Financial Reporting

10 Independent Auditor’s Report

11 Financial Statements

15 Notes to Financial Statements

Convertible Debenture Trust 22 Annual Management Report

of Fund Performance

27 Management’s Responsibility for Financial Reporting

27 Independent Auditor’s Report

28 Financial Statements

32 Notes to Financial Statements

38 Distributions

39 2012 Tax Information

40 Middlefield Funds Family

Corporate Information

MIDDLEFIELD 2012 ANNUAL REPORT 3

MIDDLEFIELD TSX-LISTED FUNDS

2012Review and OutlookIn 2012, both U.S. and European policy makers struggled to implement reforms aimed at minimizing the economic impact of fiscal imbalances. Heading into 2013, policy risk has diminished, emerging market inflation has moderated and corporate balance sheets remain strong. U.S. economic growth is accelerating, led by an improved labor market, a recovery in housing and a decline in household leverage. In Europe, the Central Bank has taken decisive steps towards being a lender of last resort. Although Europe will likely experience recession in 2013, modest economic growth is expected to resume by 2014 as stress in peripheral countries eventually eases due to lower funding requirements and improved competitiveness. The slower growth currently being experienced by emerging economies has been affected by deliberate policy decisions designed to curb inflation and diminished demand from developed markets as governments, financial institutions and households deleverage. We continue to believe that sustainable long-term global growth will require both structural reforms to facilitate deleveraging in developed economies and socio-economic improvements to increase domestic demand in emerging markets.

Despite the broader market volatility, several of our funds delivered strong performance last year. The REIT INDEXPLUS Income Fund and the Pathfinder Convertible Debenture Fund generated total returns of 17.4% and 5.1%

respectively. Both funds continued to benefit from the low interest rate environment in North America, which we expect to prevail for the foreseeable future. In 2012, we successfully launched two new TSX-listed funds that leverage our expertise in equity income investing, including Middlefield Income Plus II Corp., which was designed to track the performance of our Lipper Award winning Income Plus Class mutual fund, and the Middlefield Can-Global REIT Income Fund. Our funds remain well positioned to capitalize on the relative strength of the Canadian economy and broad based demand for natural resources.

We remain positive on the long-term outlook for oil and natural gas and maintain the view that North American natural gas and global oil production have peaked. We believe that long-term oil prices will be in the range of US$80 to US$100 per barrel during the next five years as new supply remains expensive to develop. We expect the spread between WTI and Brent oil prices to narrow by the end of 2013, with WTI appreciating relative to Brent. Several energy infrastructure projects will eventually alleviate the bottleneck at the Cushing terminus in Oklahoma, which has currently widened heavy oil differentials and reduced the profitability of many Canadian oil producers. Increased access to U.S. refineries should cause heavy oil differentials to narrow and benefit the Canadian energy sector.

THE MIDDLEFIELD FAMILY OF EXCHANGE-LISTED

FUNDS CURRENTLY COMPRISES 14 FUNDS, 13 OF WHICH TRADE ON THE TORONTO STOCK

EXCHANGE AND ONE OF WHICH IS BASED IN JERSEY, CHANNEL ISLANDS AND TRADES

ON THE LONDON STOCK EXCHANGE. THE VARIOUS FUNDS DIFFER BY ASSET MIX AND

ARE PRIMARILY FOCUSED ON BOTH FIXED INCOME AND EQUITY INCOME SECURITIES.

4 PATHFINDER CONVERTIBLE DEBENTURE FUND

2012 REVIEW AND OUTLOOK

Natural gas inventories have increased significantly over the last 24 months due to increased shale production and warmer than expected winters. As a result, natural gas prices fell below $2 per million btu in the first half of 2012. Looking forward, gas prices will be supported by utilities switching from coal to gas fired electrical power generation and increased industrial demand. We remain optimistic that medium-to-long term natural gas prices will increase significantly as producers have already begun to announce production cuts and slow drilling activity, evidenced by the number of U.S. natural gas rigs in operation being at a 13 year low. Fundamentals continue to suggest that shale gas production will not offset declines in conventional, Gulf of Mexico and associated gas supply.

We believe that gold prices in the near term could approach US$2,000 per ounce due to rising production costs exceeding US$1,300 per ounce and demand from Central Banks that want to diversify their foreign reserve holdings. Growth in developing economies and emerging economies should have a positive impact on demand for base metals and other commodities. Supply constraints will support higher commodity prices as a number of sectors are facing significant challenges, including the difficulty of finding new material deposits, environmental opposition, and the threat of nationalization or fiscal/royalty changes in some of the most promising regions for resource development.

Our newly launched Middlefield Can-Global REIT Income Fund is expected to benefit from strong fundamentals in the Canadian and global real estate sectors. We believe REITs will remain an attractive asset class due to their ability to offer investors a tax-efficient source of steady income and the potential for stable long-term total returns. Developers in

Canada and abroad are keeping supply well balanced with demand, which has generally been supportive of rising occupancy and rents. Furthermore, life insurance companies and pension funds are expected to continue to increase their allocations to real estate relative to publicly listed equities and low-yielding fixed income alternatives. We believe that continued access to low-cost capital and strong fundamentals will support cash flows and drive dividend increases in 2013.

Our TSX listed funds are well positioned to take advantage of attractive investment opportunities among natural resource, real estate and income-oriented issuers, which should continue to perform well in a low interest rate environment and benefit from a demographic demand for income. Historically, dividend-paying companies have exhibited less volatility and significantly outperformed non-dividend paying stocks. As demonstrated by our longstanding track record, Middlefield remains committed to focusing on and investing in income securities with a bias towards high quality companies with low debt and stable levels of interest and dividends. Moreover, we continue to believe that Canada’s well-capitalized banking system, stable economy and abundance of natural resources continues to provide investors with very attractive long-term investment opportunities.

Dean Orrico Robert F. LauzonPresident and Managing Director and Chief Investment Officer Senior Portfolio Manager


ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCEFOR THE YEAR ENDED DECEMBER 31, 2012

This annual management report of fund performance contains financial highlights and should be read in conjunction with the complete audited annual financial statements of the investment fund that follow this report.

Unitholders may contact us by calling 1-888-890-1868, by writing to us at Middlefield Group at one of the addresses on the back cover or by visiting our website at www.middlefield.com to request a copy of the investment fund’s proxy voting policies and procedures, proxy voting disclosure record or quarterly portfolio disclosure.

Management’s Discussion of Fund Performance

INVESTMENT OBJECTIVE AND STRATEGIESThe investment objectives of Pathfinder Convertible Debenture Fund (the “Fund”) are to (i) pay monthly distributions to unitholders on a tax-advantaged basis initially targeted to be 6.5% per annum on the original issue price of $12.00 per combined unit and (ii) maximize total after-tax returns for unitholders over the life of the Fund. Virtually all of the net proceeds of the initial public offering were used to pre-pay the Fund’s obligations under a forward purchase and sale agreement (the “Forward Agreement”) with a counterparty. These proceeds have been invested by the counterparty in units of Convertible Debenture Trust (“CDT”), the underlying fund, which then used the proceeds to acquire a portfolio of securities (the “Portfolio”). The Fund has economic exposure to the Portfolio, which is comprised of convertible debentures and other securities.

RISK The Fund is exposed to several risks that may affect its performance. The overall risk of the Fund is as described in the Fund’s prospectus dated August 23, 2012 and in CDT’s prospectus dated October 28, 2009. During 2012, the Fund’s overall risk level may have been impacted as follows:

Market RiskMarket risk describes the Fund’s exposure to volatility in the market value of its underlying securities. Equity markets and commodity prices continued to exhibit volatility in 2012 due to macroeconomic uncertainty and Canadian oil prices traded at an abnormally large discount to American benchmarks due to limited pipeline capacity. The instability in commodity prices and energy pricing differential led to increased market risk. The Fund seeks to mitigate risk through active management, portfolio diversification and through consultation with Groppe, Long & Littell (“Groppe”), an oil and natural gas consulting firm based in Houston, who acts as a Special Advisor to Middlefield Capital

Corporation, the advisor to the Fund (“MCC” or the “Advisor”). Groppe provides analysis of the global and political forces impacting the prices of oil and natural gas.

RESULTS OF OPERATIONS Investment Performance The Fund has economic exposure to the Portfolio of CDT by virtue of the Forward Agreement. With respect to CDT’s investment strategy, the Portfolio has a significant weighting in convertible debentures. However, to provide further diversification and incremental income, Middlefield Limited (the “Manager”) has added selected dividend-paying equities and high yield corporate bonds to the Portfolio. In order to mitigate risk, we continue to focus on the better quality companies that possess high quality assets, low payout ratios, modest levels of third party debt and proven management teams.

The net assets of the Fund increased from $73.6 million at December 31, 2011 to $104.4 million at December 31, 2012 primarily as a result of a treasury offering which raised $43 million in August 2012. Net assets on a per unit basis decreased from $11.47 at December 31, 2011 to $11.26 at December 31, 2012. The per unit decrease reflects the impact of distributions and expenses paid during 2012.

Revenue and Expenses Revenue for 2012 decreased from approximately $35,000 to approximately $21,500 reflecting a decrease in interest earned on the Fund’s cash balances. Expenses decreased by approximately $0.1 million to $1.6 million from the prior year primarily due to a decrease in average net assets under management. Net investment loss decreased 5.8% to $1.6 million in 2012 and on a per unit basis remained flat at $0.21. Distributions for the year ended December 31, 2012 amounted to $0.78 per unit.

LeverageThe Forward Agreement enables the Fund to leverage its exposure to CDT by up to 25% of total assets. At December 31, 2012, leverage through the Forward Agreement amounted to $15 million representing approximately 12.4% of total assets and 14.4% of net assets. The minimum and maximum leverage outstanding during 2012 was $15 million for both. The leverage is used to increase the Forward Agreement and hence the Fund’s exposure to the Portfolio.

Trends In 2012, both U.S. and European policy makers struggled to implement reforms aimed at minimizing the economic impact of fiscal imbalances. While volatility is expected to persist in 2013, policy risk has diminished, emerging market inflation has moderated and corporate balance sheets remain strong. U.S. economic growth is accelerating, led by an improved labor market, a recovery in housing and a decline in household leverage.



Although Europe will likely experience a recession in 2013, economic growth is expected to resume several quarters thereafter as stress in peripheral countries eventually eases due to lower funding requirements and improved competitiveness. We continue to believe that sustainable long-term global growth will require structural reforms to facilitate deleveraging in developed economies and socio-economic improvements that will increase domestic demand in emerging markets, which remain well supported by accommodative fiscal and monetary policies.

The demand for Canadian high yield debt and convertible bonds remained strong in 2012. A total of $3.1 billion in convertible bonds was raised across 50 new issues, and the overall size of the convertible bond market currently exceeds $14 billion. Similarly, a total of $5.2 billion of new high yield debt was issued across 17 transactions, which increased the size of the high yield debt market to over $13 billion. Looking forward, we expect convertible and high yield bonds to perform well as capital continues to flow into these securities from investors seeking higher yielding investment alternatives.

RELATED PARTY TRANSACTIONS Pursuant to a management agreement, the Manager receives a management fee. For further details please see the “Management Fees” section of this report.

MANAGEMENT FEESManagement fees, including those paid in respect of CDT, are calculated at 0.85% per annum of the Net Asset Value of the Fund and are split between the Manager and the Advisor. The Manager receives fees for the general administration of the Fund, including maintaining the accounting records, executing securities trades, monitoring compliance with regulatory requirements, and negotiating contractual agreements, among other things. The Advisor receives fees from CDT in respect of investment advice provided to that fund.

RECENT DEVELOPMENTS On December 12, 2012, the Fund received approval from the Toronto Stock Exchange to make a normal course issuer bid for its units. The notice of intent (the “Notice”) enables the Fund to purchase up to 934,852 units, being 10% of the public float of the units, during the 12 month period from December 14, 2012 to December 13, 2013. Unitholders may obtain a copy of the Notice, without charge, by contacting the Fund.

On August 31, 2012, the Fund closed its treasury offering, raising gross proceeds of $43 million. Units were issued at $12.33 per unit, the net asset value at the time plus the agents’ fees and expected expenses of the offering. Virtually all of the net proceeds of this offering have been used to increase the Forward Agreement.

Future Accounting ChangesInternational Financial Reporting Standards (“IFRS”)Canadian publicly accountable enterprises, which include funds/investment trusts, will be required to prepare financial statements in accordance with IFRS, as issued by the International Accounting Standards Board (“IASB”). On December 12, 2011, the Canadian Accounting Standards Board (“AcSB”) amended the deadline for adoption of IFRS for investment companies to fiscal years beginning on or after January 1, 2014. Accordingly, the Fund will adopt IFRS for its fiscal year beginning January 1, 2014, and will issue its initial financial statements in accordance with IFRS, including comparative information, for the interim period ending June 30, 2014.

The Manager has developed an IFRS changeover plan, which addresses key elements of the conversion to IFRS and has identified the key differences between IFRS and Canadian generally accepted accounting principles (“GAAP”) that are expected to affect the Fund. Elements of the plan include evaluating the impacts of the changeover on all business activities, accounting policies, information technology and data systems, internal controls over financial reporting and disclosure controls and procedures.

Based on the Manager’s current evaluation of the differences between GAAP and IFRS, the adoption of IFRS is not expected to have a significant impact on the calculation of net asset value per unit. IFRS is expected to affect the overall presentation of financial statements and result in additional disclosure in the accompanying notes, particularly in relation to the classification of puttable instruments. Based on initial assessment, the Fund’s units would be classified as a liability under IAS 32 – “Financial Instruments Presentation”. Reclassification of the Fund’s units is not expected to have a material impact on the net asset value per unit on adoption. The Manager has not yet assessed the October 2012 changes to IAS 27 – “Consolidated Financial Statements and Accounting for Investments in Subsidiaries” and therefore cannot conclude on the impact of these changes on the Fund. The Manager continues to monitor changes to IFRS proposed by the IASB and relevant amendments by the AcSB, and the current assessment and IFRS changeover plan may change if new standards are issued or interpretations of existing standards are revised.



FINANCIAL HIGHLIGHTSThe following tables show selected key financial information about the Fund and are intended to help you understand the Fund’s financial performance for the indicated periods. “Net Assets” are calculated in accordance with the Canadian Institute of Chartered Accountants Handbook section 3855 “Financial Instruments – Recognition and Measurement” (“Section 3855”) and are used for financial reporting purposes.

“Net Asset Value” is calculated in accordance with section 14.2 of National Instrument 81-106 “Investment Fund Continuous Disclosure” (“NI 81-106”) and is used for transactional pricing purposes. Section 3855 requires the use of valuation techniques for certain types of investments that may differ from those prescribed by NI 81-106. Ratios and supplemental data are derived from the Fund’s Net Asset Value.

THE FUND’S NET ASSETS PER UNIT (1)

2012 2011 2010 2009(4)

Net Assets, Beginning of Year $ 11.47 $ 12.48 $ 11.35 $ 11.26

INCREASE (DECREASE) FROM OPERATIONS:Total Revenue – – – –Total Expenses (0.21) (0.21) (0.20) (0.03)Realized Gains for the Year 0.23 1.00 0.10 –Unrealized Gains (Losses) for the Year 0.41 (0.82) 2.42 0.19

TOTAL INCREASE (DECREASE) FROM OPERATIONS (2) 0.57 (0.23) 1.91 0.16

DISTRIBUTIONS:From Capital Gains 0.23 0.78 0.10 –From Return of Capital 0.55 – 0.68 0.07

TOTAL DISTRIBUTIONS (3) 0.78 0.78 0.78 0.07

Net Assets, End of Year $ 11.26 $ 11.47 $ 12.48 $ 11.35

(1) This information is derived from the Fund’s audited annual financial statements. The Net Assets per unit presented in the financial statements differs from the Net Asset Value calculated for fund pricing purposes. An explanation of these differences can be found in the notes to the financial statements.

(2) Net Assets and distributions are based on the actual number of units outstanding at the relevant time. The increase (decrease) from operations is based on the weighted average number of units outstanding over the financial period.

(3) Distributions were paid in cash/reinvested in additional units of the Fund, or both.(4) For the period November 20, 2009 (date of commencement of operations) to December 31, 2009.

RATIOS AND SUPPLEMENTAL DATA 2012 2011 2010 2009(5)

Total Assets (000s) (1) $ 121,391 $ 89,827 $ 142,471 $ 72,002Total Net Asset Value (000s) (1) $ 105,118 $ 74,060 $ 126,325 $ 70,900Number of Units Outstanding (1) 9,270,784 6,419,013 10,058,619 6,223,000Management Expense Ratio (“MER”) (2) 4.19% 1.62% 3.17% 2.60%MER excluding interest expense and issuance costs (2) 1.47% 1.35% 1.40% 1.58%Trading Expense Ratio (3) – – – –Portfolio Turnover Rate (4) 21.99% 38.43% 8.48% –Net Asset Value per Unit $ 11.34 $ 11.54 $ 12.56 $ 11.39Closing Market Price $ 11.56 $ 11.18 $ 12.20 $ 12.14

(1) This information is provided as at December 31 of the year shown.(2) The MER is based on total expenses (excluding commissions and other portfolio transaction costs) for the stated period and is expressed as

an annualized percentage of daily average Net Asset Value during the period. The MER excluding interest expense and issuance costs has been presented separately as it expresses only the ongoing management and administrative expenses as a percentage of average Net Asset Value. Issuance costs are one-time costs incurred at inception and the inclusion of interest expense does not consider the additional earnings that have been generated from the investment of the leverage.

(3) The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average Net Asset Value during the period.

(4) The Fund’s portfolio turnover rate indicates how actively the Fund’s portfolio investments are managed. A portfolio turnover rate of 100% is equivalent to the Fund buying and selling all of the securities in its portfolio once in the course of the year. The higher the Fund’s portfolio turnover rate in a year, the greater the trading costs payable by the Fund in the year, and the greater the chance of an investor receiving taxable capital gains in the year. There is not necessarily a relationship between a high turnover rate and the performance of a fund.

(5) For the period November 20, 2009 (date of commencement of operations) to December 31, 2009.



ANNUAL COMPOUND RETURNS Periods Ended December 31, 2012 Since One Year Three Years Inception

Pathfinder Convertible Debenture Fund 5.07% 6.59% 6.97%S&P/TSX Composite Index 7.17% 4.78% 5.23%

The S&P/TSX Composite Index (the “Index”) is comprised of Canadian stocks traded on the Toronto Stock Exchange and is designed to represent the Canadian equity market.

The Fund underperformed the Index in 2012 returning 5.07% compared to the Index total return of 7.17%. Since inception, the Fund has posted an annual compound return of 6.97% compared to the broad equity market which returned 5.23%. The Fund’s underperformance in 2012 relative to the broad equity market reflects the strength in investor demand for higher yielding securities including convertible debentures issued by Canadian companies.

PAST PERFORMANCEThe performance information shown, which is based on Net Asset Value, assumes that all distributions paid by the Fund in the periods shown were reinvested in additional securities of the Fund. The performance information does not take into account sales, redemption, distribution or other optional charges that would have reduced returns or performance. How the Fund has performed in the past does not necessarily indicate how it will perform in the future.

YEAR-BY-YEAR RETURNSThe bar chart shows how the Fund’s performance has varied from year-to-year for each of the years shown. The return for 2009 is not presented since it relates to a partial period. The chart indicates, in percentage terms, how much an investment made the first day of each financial year would have grown or decreased by the last day of the financial year.

-10

0

10

20

ANNUAL TOTAL RETURNS %

20122010 2011

17.73

5.07

-2.06



Summary of Investment PortfolioAS AT DECEMBER 31, 2012

The Fund is exposed to the economic risks of Convertible Debenture Trust by virtue of the Forward Agreement. As a result, details of the holdings of CDT, not the Fund, are presented below.

TOP TWENTY-FIVE HOLDINGS OF CONVERTIBLE DEBENTURE TRUST

DESCRIPTION % OF NET ASSET VALUE

1 Lake Shore Gold Corp. 6.25% due September 30, 2017 3.02 Southern Pacific Resource Corp. 6.0% due June 30, 2016 2.93 Uranium One Inc. 5.0% due March 13, 2015 2.54 WesternOne Inc. 8.5% due December 31, 2015 2.55 Parex Resources Inc. 5.25% due June 30, 2016 2.56 Equal Energy Ltd. 6.75% due March 31, 2016 2.57 Advantage Oil & Gas Ltd. 5.0% due January 30, 2015 2.58 Angle Energy Inc. 5.75% due January 31, 2016 2.59 Ag Growth International Inc. 7.0% due December 31, 2014 2.4

10 Chorus Aviation Inc. 9.5% due December 31, 2014 2.311 Dundee Industrial Real Estate Investment Trust 2.312 Arcan Resources Ltd 6.50% due October 31, 2018 2.313 Inmet Mining Corp. 8.75% due June 1, 2020 2.214 Savanna Energy Services Corp. 7.0% due May 25, 2018 2.115 Extendicare Real Estate Investment Trust 6.0% due September 30, 2019 2.116 Gateway Casinos & Entertainment Ltd. 8.875% due November 15, 2017 1.917 Gamehost Inc. 6.25% due July 31, 2015 1.918 Aecon Group Inc. 7.0% due September 30, 2014 1.919 Canexus Corporation 5.75% due December 31, 2018 1.920 Pengrowth Energy Corporation 6.25% due December 31, 2014 1.921 Chemtrade Logistics Income Fund 5.75% due December 31, 2018 1.822 IAMGOLD Corporation 6.75% due October 1, 2020 1.823 Western Energy Services Corp. 7.875% due January 30, 2019 1.824 Newalta Corporation 7.625% due November 23, 2017 1.825 Tricon Capital Group Inc. 6.375% due August 31, 2017 1.7

“Top Twenty-Five Holdings” excludes any temporary cash investments.

ASSET CLASS OF CONVERTIBLE DEBENTURE TRUST % OF NET ASSET VALUE

Convertible Debentures 79.9Energy 2.9Real Estate 2.3Preferred Shares 0.9Cash and Short-Term Investments 13.2Other Assets (Liabilities) 0.8

100.0

TOTAL NET ASSET VALUE OF CONVERTIBLE DEBENTURE TRUST $ 121,187,441

TOTAL ASSETS OF CONVERTIBLE DEBENTURE TRUST $ 121,283,886

The Summary of Investment Portfolio may change over time due to ongoing portfolio transactions. Please visit www.middlefield.com for the most recent quarter-end Summary of Investment Portfolio.


The financial statements of Pathfinder Convertible Debenture Fund (the “Fund”) have been prepared by Middlefield Limited (the “Manager”), the manager of the Fund and approved by the Board of Directors. The Manager is responsible for the information and representations contained in these financial statements and other financial information contained in this annual report.

The Manager maintains appropriate procedures to ensure that relevant and reliable financial information is produced. The financial statements have been prepared in accordance with Canadian generally accepted accounting principles and include certain amounts that are based on estimates and judgements. The significant accounting policies applicable to the Fund are described in the notes to the financial statements.

The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and has reviewed and approved these financial statements.

Deloitte LLP is the external auditor of the Fund. They have audited the financial statements of the Fund in accordance with Canadian generally accepted auditing standards to enable them to express to unitholders their opinion on the financial statements.

Robert F. Lauzon Francisco Z. Ramirez President Senior Vice-President Middlefield Limited and Chief Financial Officer Middlefield Limited March 13, 2013

TO THE UNITHOLDERS OF PATHFINDER CONVERTIBLE DEBENTURE FUNDWe have audited the accompanying financial statements of Pathfinder Convertible Debenture Fund, which comprise the statement of investment portfolio as at December 31, 2012, the statements of net assets as at December 31, 2012 and 2011, and the statements of operations, changes in net assets and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information.

MANAGEMENT’S RESPONSIBILITY FOR THE FINANCIAL STATEMENTSManagement is responsible for the preparation and fair presentation of these financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

AUDITOR’S RESPONSIBILITYOur responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend

on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

OPINIONIn our opinion, the financial statements present fairly, in all material respects, the financial position of Pathfinder Convertible Debenture Fund as at December 31, 2012 and 2011, and the results of its operations, changes in its net assets and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Chartered Professional Accountants, Chartered Accountants Licensed Public Accountants Toronto, Ontario

March 13, 2013

INDEPENDENT AUDITOR’S REPORT

MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING

FINANCIAL STATEMENTS


STATEMENTS OF NET ASSETSAS AT DECEMBER 31 2012 2011

ASSETS:Forward Agreement at Fair Value (Note 9) $ 120,453,350 $ 88,935,886Cash 184,916 425,714Account Receivable 18,298 10,678

120,656,564 89,372,278

LIABILITIES:Loan Payable (Note 8) 15,000,000 15,000,000Accounts Payable and Accrued Liabilities 663,761 343,306Unitholder Distributions Payable 608,438 423,157

16,272,199 15,766,463

Net Assets $ 104,384,365 $ 73,605,815

Units Issued and Outstanding (Note 11) 9,270,784 6,419,013

Net Assets per Unit (Note 7) $ 11.26 $ 11.47 Approved by the Board of Directors of Middlefield Limited, as Manager:

Director: Robert F. Lauzon Director: Francisco Z. Ramirez

STATEMENTS OF OPERATIONSFOR THE YEARS ENDED DECEMBER 31 2012 2011

INVESTMENT INCOME:Interest $ 21,447 $ 35,027

EXPENSES (Note 10):Service Fees 452,877 480,389Forward Agreement Fees (Note 9) 373,181 396,515Interest and Bank Charges 335,089 351,725Management Fee 238,168 266,095Fund Administration 92,031 89,702Unitholder Reporting Costs 60,907 71,687Audit Fees 25,482 25,762Independent Review Committee Fees and Expenses 10,000 11,000Legal 6,367 10,053Director Fees 1,143 2,226

1,595,245 1,705,154

Net Investment Loss (1,573,798) (1,670,127)

NET GAIN (LOSS) ON FORWARD AGREEMENT:Net Realized Gain on Forward Agreement 1,688,590 8,077,707Change in Net Unrealized Gain (Loss) on Forward Agreement 3,023,466 (6,673,073)

Net Gain on Forward Agreement 4,712,056 1,404,634

Net Increase (Decrease) in Net Assets from Operations $ 3,138,258 $ (265,493)

Net Increase (Decrease) in Net Assets from Operations per Unit (Note 11) $ 0.43 $ (0.03)

The accompanying notes to financial statements are an integral part of these financial statements.



STATEMENTS OF CHANGES IN NET ASSETSFOR THE YEARS ENDED DECEMBER 31 2012 2011

Net Assets at Beginning of Year $ 73,605,815 $ 125,534,061

OPERATIONS:Net Increase (Decrease) in Net Assets from Operations 3,138,258 (265,493)

DISTRIBUTIONS TO UNITHOLDERS:From Realized Gain on Forward Agreement (1,688,590) (6,203,362)From Return of Capital (4,244,886) –

(5,933,476) (6,203,362)

UNITHOLDER TRANSACTIONS:Proceeds from Issue of Trust Units, Net 41,345,335 373,466Repurchase of Trust Units (3,610,039) (1,294,783)Payment on Redemption of Trust Units (4,161,528) (44,538,074)

33,573,768 (45,459,391)

Net Increase (Decrease) in Net Assets 30,778,550 (51,928,246)

Net Assets at End of Year $ 104,384,365 $ 73,605,815

Total Assets $ 120,656,564 $ 89,372,278

Distributions per Unit (Note 12) $ 0.78 $ 0.78

STATEMENTS OF CASH FLOWSFOR THE YEARS ENDED DECEMBER 31 2012 2011

OPERATING ACTIVITIES:Net Increase (Decrease) in Net Assets from Operations $ 3,138,258 $ (265,493)Adjustments: Purchase of Forward Agreement (49,116,866) (43,922,309) Proceeds of Disposition of Forward Agreement 22,311,458 95,922,325 Net Realized Gain on Forward Agreement (1,688,590) (8,077,707) Change in Net Unrealized (Gain) Loss on Forward Agreement (3,023,466) 6,673,073

(28,379,206) 50,329,889Net Change in Non-Cash Working Capital 312,835 (118,033)

(28,066,371) 50,211,856

FINANCING ACTIVITIES:Proceeds from Issue of Trust Units, Net 41,345,335 373,466Repurchase of Trust Units (3,610,039) (1,294,783)Payment on Redemption of Trust Units (4,161,528) (44,538,074)Distributions Paid to Unitholders (5,748,195) (6,447,977)

27,825,573 (51,907,368)

Net Decrease in Cash (240,798) (1,695,512)Cash at Beginning of Year 425,714 2,121,226

Cash at End of Year $ 184,916 $ 425,714

SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION

Loan Interest Paid $ 307,019 $ 305,976




STATEMENT OF INVESTMENT PORTFOLIOAS AT DECEMBER 31, 2012

No. of Securities Description /Par Value Average Cost Fair Value

Advantage Oil & Gas Ltd. 5.0% due January 30, 2015 3,000,000 $ 3,043,277 $ 2,985,000Aecon Group Inc. 7.0% due September 30, 2014 2,250,000 2,354,060 2,340,000Ag Growth International Inc. 7.0% due December 31, 2014 2,750,000 2,856,855 2,853,125Allied Nevada Gold Corp. 8.75% due June 01, 2019 975,000 963,865 1,016,438Anderson Energy Ltd. 7.50% due January 31, 2016 2,200,000 2,200,000 1,397,000Angle Energy Inc. 5.75% due January 31, 2016 3,000,000 2,940,566 2,970,000Arcan Resources Ltd. 6.50% due October 31, 2018 3,100,000 2,934,483 2,635,000Arcan Resources Ltd. 6.25% due February 28, 2016 250,000 180,699 218,125Bellatrix Exploration Ltd. 4.75% due April 30, 2015 1,500,000 1,516,875 1,558,500C2C Industrial Properties Inc. 6.75% due November 30, 2017 1,250,000 1,250,000 1,225,000Canexus Corporation 5.75% due December 31, 2018 2,250,000 2,325,884 2,310,750Capstone Infrastructure Corporation 6.50% due December 31, 2016 350,000 362,501 363,650Celtic Exploration Ltd. 5.0% due April 30, 2017 1,000,000 1,000,000 1,340,100Centric Health Corporation 6.75% due October 31, 2017 1,250,000 1,250,000 1,002,500Chartwell Seniors Housing Real Estate Investment Trust 5.70% due March 31, 2018 850,000 916,105 915,875Chemtrade Logistics Income Fund 5.75% due December 31, 2018 2,150,000 1,999,500 2,213,855Chorus Aviation Inc. 9.50% due December 31, 2014 2,750,000 2,801,075 2,825,625Detour Gold Corporation 5.50% due November 30, 2017 1,500,000 1,512,005 1,578,493Estrella International Energy Services Ltd. 12.0% due December 31, 2015 533,650 533,650 453,603Equal Energy Ltd. 6.75% due March 31, 2016 3,000,000 2,981,145 2,985,000Extendicare Inc. 6.0% due September 30, 2019 2,500,000 2,500,000 2,556,250First Capital Realty Inc. 5.25% due January 31, 2019 684,000 697,045 697,680Fortress Paper Ltd. 7.0% due December 31, 2019 1,000,000 1,000,000 713,500Gamehost Inc. 6.25% due July 31, 2015 2,000,000 1,929,400 2,336,200Gateway Casinos & Entertainment Ltd. 8.875% due November 15, 2017 2,250,000 2,320,000 2,362,500HudBay Minerals Inc 9.50% due October 01, 2020 750,000 766,022 789,713IAMGOLD Corporation 6.75% due October 01, 2020 2,250,000 2,161,634 2,184,314Inmet Mining Corp. 8.75% due June 01, 2020 2,500,000 2,524,790 2,712,806InnVest Real Estate Investment Trust 5.85% due August 01, 2014 750,000 710,935 750,000InnVest Real Estate Investment Trust 6.0% due September 30, 2017 2,000,000 2,007,500 1,942,200InnVest Real Estate Investment Trust 5.75% due March 30, 2018 850,000 821,494 816,000Just Energy Group Inc. 6.0% due June 30, 2017 1,000,000 988,352 822,500Killam Properties Inc. 5.65% due November 30, 2017 1,250,000 1,251,590 1,328,750Kirkland Lake Gold Inc 7.50% due December 31, 2017 400,000 400,000 400,000Lake Shore Gold Corp. 6.25% due September 30, 2017 4,000,000 4,000,000 3,648,000Lone Pine Resources Ltd. 10.375% due February 15, 2017 500,000 501,827 467,978Minexco Petroleum Inc. 7.0% due November 29, 2017 700,000 694,893 696,990New Gold Inc. 7.0% due April 15, 2020 1,000,000 1,006,447 1,025,570Newalta Corporation 7.625% due November 23, 2017 2,000,000 2,043,750 2,148,750Niko Resources Ltd 7.0% due December 31, 2017 800,000 803,783 880,000North American Palladium Ltd. 6.15% due September 30, 2017 750,000 713,438 597,000Paladin Energy Ltd. 6.0% due April 30, 2017 1,850,000 1,806,781 1,655,996

The accompanying notes to financial statements are an integral part of this financial statement.



STATEMENT OF INVESTMENT PORTFOLIO (CONTINUED)AS AT DECEMBER 31, 2012


Paramount Resources Ltd. 8.25% due December 13, 2017 2,000,000 $ 2,000,000 $ 2,070,764Parex Resources Inc. 5.25% due June 30, 2016 3,000,000 2,986,508 2,985,000Pengrowth Energy Corporation 6.25% due December 31, 2014 2,250,000 2,250,000 2,295,000Perpetual Energy Inc. 7.25% due January 31, 2015 500,000 487,005 472,500Perpetual Energy Inc. 7.0% due December 31, 2015 750,000 702,322 705,000Perpetual Energy Inc. 8.75% due March 15, 2018 1,500,000 1,305,000 1,447,500Savanna Energy Services Corp. 7.0% due May 25, 2018 2,500,000 2,532,500 2,558,333Sherritt International Corporation 7.50% due September 24, 2020 750,000 750,000 768,430Southern Pacific Resource Corp. 6.0% due June 30, 2016 3,500,000 3,583,097 3,538,500Superior Plus Corp. 7.50% due December 31, 2014 750,000 780,188 776,250TransGlobe Energy Corporation 6.0% due March 31, 2017 1,500,000 1,519,375 1,507,500Tricon Capital Group Inc. 6.375% due August 31, 2017 1,850,000 1,885,163 2,053,500Uranium One Inc. 5.0% due March 13, 2015 3,000,000 3,047,500 3,045,000Western Energy Services Corp. 7.875% due January 30, 2019 2,100,000 2,128,500 2,168,250WesternOne Inc. 8.50% due December 31, 2015 2,000,000 2,000,000 2,981,000

CONVERTIBLE DEBENTURES: 79.7% 95,529,384 96,092,863

Birchcliff Energy Ltd. – Warrants, $8.30, August 8, 2014 120,000 – 168,000Estrella International Energy Services Ltd. – Warrants, $0.80, March 3, 2015 13 – 2,401Freehold Royalties Ltd. 75,000 1,113,734 1,670,250Gibson Energy Inc. 70,000 1,449,000 1,677,900

ENERGY: 2.9% 2,562,734 3,518,551

Dundee Industrial Real Estate Investment Trust 250,000 2,477,520 2,787,500First Capital Realty Inc. 656 12,114 12,326

REAL ESTATE: 2.3% 2,489,634 2,799,826

Birchcliff Energy Ltd. 8.0% Preferred Due September 30, 2017 40,000 1,000,000 1,052,400

PREFERRED SHARES: 0.9% 1,000,000 1,052,400

EMBEDDED BROKER COMMISSIONS (56,323) –

TOTAL INVESTMENTS HELD BY CONVERTIBLE DEBENTURE TRUST: 85.8% 101,525,429 103,463,640CASH HELD BY CONVERTIBLE DEBENTURE TRUST: 13.2% 15,961,181 15,961,181OTHER NET ASSETS OF CONVERTIBLE DEBENTURE TRUST: 0.8% 1,028,529 1,028,529

FORWARD AGREEMENT: 99.8% 118,515,139 120,453,350CASH: 0.2% 184,916 184,916

Total Investment Portfolio, including Cash $ 118,700,055 $ 120,638,266


DECEMBER 31, 2012 AND 2011NOTES TO FINANCIAL STATEMENTS


1. PATHFINDER CONVERTIBLE DEBENTURE FUNDPathfinder Convertible Debenture Fund (the “Fund”) is a closed-end investment trust established under the laws of the Province of Alberta on October 28, 2009. Middlefield Limited (the “Manager”), a company incorporated in Alberta, is both the manager and trustee of the Fund. Middlefield Capital Corporation (“MCC” or the “Advisor”), a company under common control with the Manager, is the advisor to the Fund. The Fund was listed on the Toronto Stock Exchange (“TSX”) and effectively commenced operations on November 20, 2009 when it first issued combined units through an initial public offering.

2. INVESTMENT OBJECTIVES AND STRATEGYThe Fund’s investment objectives are to (i) pay monthly distributions to unitholders on a tax-advantaged basis initially targeted to be 6.5% per annum on the original issue price of $12.00 per combined unit and (ii) maximize total after-tax returns for unitholders over the life of the Fund. Virtually all of the net proceeds of the initial public offering were used to pre-pay the Fund’s obligations under a forward purchase and sale agreement (the “Forward Agreement”) with a counterparty. These proceeds have been invested by the counterparty in units of Convertible Debenture Trust (“CDT”), the underlying fund, which then used the proceeds to acquire a portfolio of securities (the “Portfolio”). The Fund has economic exposure to the Portfolio, which is comprised of convertible debentures and other securities.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. FUTURE ACCOUNTING CHANGESInternational Financial Reporting Standards (“IFRS”)Canadian publicly accountable enterprises, which include funds/investment trusts, will be required to prepare financial statements in accordance with IFRS, as issued by the International Accounting Standards Board. On December 12, 2011, the Canadian Accounting Standards Board amended the deadline for adoption of IFRS for investment companies to fiscal years beginning on or after January 1, 2014. Accordingly, the Fund will adopt IFRS for its fiscal year beginning January 1, 2014, and will issue its initial financial statements in accordance with IFRS, including comparative information, for the interim period ending June 30, 2014.

B. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTSThe Fund’s own credit risk and the credit risk of the counterparty is taken into account in determining the fair value of financial assets and financial liabilities, including derivative instruments. Management has reviewed its policies concerning valuation of assets and liabilities and determined that the fair values ascribed to the financial assets and financial liabilities in the Fund’s financial statements incorporate appropriate levels of credit risk.

C. INVESTMENTS AT FAIR VALUE Securities listed on a recognized public stock exchange are valued at their closing bid price on the valuation date. Securities with no available bid price are valued at their closing trade price. Securities not listed on a recognized public stock exchange are valued based on recent transactions between willing parties, if such information is available, or alternatively valued using valuation techniques which may include the use of the operating results of the investees, expected future cash flows discounted at appropriate discount rates and comparable peer group valuations adjusted for company specific circumstances. Bonds and debentures are valued at their closing bid price on the valuation date.

D. INVESTMENT TRANSACTIONS AND INCOME RECOGNITIONInvestment transactions are accounted for as of the trade date and any realized gains or losses from such transactions are calculated on an average cost basis. The change in the difference between fair value and average cost of the investments is recorded as unrealized gain (loss) on investments. Income from investments is recognized on the ex-dividend or ex-distribution date. Interest income is recognized on an accrual basis.

E. NET INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS PER UNITNet increase (decrease) in net assets from operations per unit in the Statements of Operations represents the increase (decrease) in net assets from operations divided by the average units outstanding during the year.

F. INCOME TAXESThe Fund qualifies as a mutual fund trust under the provisions of the Income Tax Act (Canada). Under the terms of the Declaration of Trust, any taxable income of the Fund is distributable monthly to unitholders of record date. The Fund is not subject to tax on the income distributed to unitholders. Accordingly, no provision for income taxes is required.

NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND 2011


3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)G. FOREIGN CURRENCY TRANSLATIONForeign currency amounts are translated into Canadian dollars as follows: currency conversions are made at the appropriate daily U.S. dollar noon rate as quoted by the Bank of Canada. Revenue and expenses and investment transactions in currencies other than Canadian dollars are translated into Canadian dollars at the rate of exchange prevailing on the date of such transactions. Investments in securities at fair value, other assets and liabilities in foreign currencies are translated into Canadian dollars at the rate of exchange prevailing at year end.

H. FINANCIAL INSTRUMENTSThe carrying values of financial instruments, including cash, receivables, payables and accruals approximate the fair value due to their short maturities.

I. USE OF ESTIMATESThe preparation of financial statements in accordance with Canadian generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the financial statements and the increase and decrease in net assets from operations during the reporting period. The most significant estimates and assumptions relate to the valuation of illiquid securities. Actual results could differ from those estimates.

4. FAIR VALUE DISCLOSUREThe tables below summarize the fair value of the Fund’s financial instruments as at December 31, 2012 and 2011 using the following fair value hierarchy:

Level 1 Inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2 Inputs other than quoted prices that are observable for the asset or liability either directly or indirectly, including inputs in markets that are not considered to be active.

Level 3 Inputs that are unobservable and where there is little, if any, market activity. Inputs into the determination of fair value require significant management judgment or estimation.

As at December 31, 2012Description Level 1 Level 2 Level 3 Total

Cash $ 184,916 $ – $ – $ 184,916Convertible Debentures held by CDT 71,642,431 23,299,839 1,150,593 96,092,863Common Shares held by CDT 3,360,476 – – 3,360,476Preferred Shares held by CDT 1,052,400 – – 1,052,400Trust Units held by CDT 2,787,500 – – 2,787,500Warrants held by CDT 168,000 2,401 – 170,401

Total $ 79,195,723 $ 23,302,240 $ 1,150,593 $ 103,648,556

As at December 31, 2011 Description Level 1 Level 2 Level 3 Total

Cash $ 425,714 $ – $ – $ 425,714Convertible Debentures held by CDT 64,163,129 9,669,758 1,105,000 74,937,887Common Shares held by CDT 3,666,257 – – 3,666,257Warrants held by CDT – 14,391 – 14,391

Total $ 68,255,100 $ 9,684,149 $ 1,105,000 $ 79,044,249

No transfers between levels have occurred during the years ended December 31, 2012 and 2011.



4. FAIR VALUE DISCLOSURE (CONTINUED)The reconciliations of investments of CDT measured at fair value using unobservable inputs (Level 3) for the years ended December 31, 2012 and 2011 are presented as follows:

2012

Balance at January 1, 2012 $ 1,105,000Purchases 694,893Proceeds from Sales (651,397)Realized Loss (114,953)Change in Unrealized Gain 117,050

Balance at December 31, 2012 $ 1,150,593

Total Change in Unrealized Gain during the Year for Assets held at December 31, 2012 $ 2,097

2011

Balance at January 1, 2011 $ –Purchases 1,300,000Change in Unrealized Loss (195,000)


Total Change in Unrealized Loss during the Year for Assets held at December 31, 2011 $ 195,000

The use of reasonable possible alternative assumptions for valuing Level 3 financial instruments of CDT would not significantly affect the fair value of those instruments.

5. FINANCIAL RISK MANAGEMENTIn the normal course of business the Fund is exposed to a variety of financial risks: interest rate risk, price risk, foreign exchange rate risk, liquidity risk and credit risk. The Fund’s primary risk management objective is to protect earnings and cash flow and, ultimately, unitholder value. Risk management strategies, as discussed below, are designed and implemented to ensure the Fund’s risks and related exposure are consistent with its objectives and risk tolerance.

The Fund invests in a Forward Agreement whose value is based on the performance of the CDT Portfolio. The Statement of Investment Portfolio presents the investments held by CDT as at December 31, 2012. Most of the Fund’s risks are derived from the investments in the Portfolio. The value of the investments can fluctuate on a daily basis as a result of changes in interest rates, economic conditions, commodity prices, the market and company news related to specific securities within the Fund. The investments are made in accordance with CDT’s risk management policies. The policies establish investment objectives, strategies, criteria and restrictions. The objectives of these policies are to identify and mitigate investment risk through a disciplined investment process and the appropriate structuring of each transaction.

A. INTEREST RATE RISK Interest rate risk describes the Fund’s exposure to changes in the general level of interest rates. Interest rate risk arises when the Fund and CDT invest in interest-bearing financial assets such as cash and debt securities and utilize financial liabilities such as loan payable. In respect of cash balances and loan payable, the Fund’s and CDT’s interest income and expense are positively correlated to interest rates in that rising interest rates increase both interest income and expense while the reverse is true in a declining interest rate environment. The Fund is also exposed to the risk that the value of financial assets held by CDT, such as convertible debentures, will fluctuate due to changes in the prevailing levels of market interest rates. The value of such financial assets is negatively correlated to interest rates. CDT seeks to mitigate this risk through active management, which involves analysis of economic indicators to forecast Canadian and global interest rates. The tables below summarize the Fund’s exposure to interest rate risk by remaining term to maturity as at December 31, 2012 and 2011 through the financial instruments held.



5. FINANCIAL RISK MANAGEMENT (CONTINUED)A. INTEREST RATE RISK (CONTINUED)

As at December 31, 2012 Less than 1 Year 1 to 5 Years Greater than 5 Years Total

Convertible Debentures held by CDT $ – $ 68,562,599 $ 27,530,264 96,092,863Preferred Shares held by CDT – 1,052,400 – 1,052,400Cash held by CDT 15,961,181 – – 15,961,181Cash held by the Fund 184,916 – – 184,916Loan Payable held by the Fund (15,000,000) – – (15,000,000)

Net Exposure $ 1,146,097 $ 69,614,999 $ 27,530,264 $ 98,291,360


Convertible Debentures held by CDT $ 6,922,250 $ 44,852,880 $ 23,162,757 $ 74,937,887Cash held by CDT 8,683,135 – – 8,683,135Cash held by the Fund 425,714 – – 425,714Loan Payable held by the Fund (15,000,000) – – (15,000,000)

Net Exposure $ 1,031,099 $ 44,852,880 $ 23,162,757 $ 69,046,736

Based on the above exposure at December 31, 2012, a 1% per annum increase or decrease in interest rates would result in a $3,267,243 (December 31, 2011 – $2,480,173) decrease or increase in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant.

B. PRICE RISKPrice risk is the risk that changes in the prices of the investments held by CDT will affect CDT’s income or the value of its financial instruments and the Fund through the Forward Agreement. The Fund’s price risk is driven primarily by volatility in commodity and equity prices. Rising commodity and equity prices may increase the price of an investment while declining commodity and equity prices may have the opposite effect. CDT mitigates price risk by making investing decisions based upon various factors, including comprehensive fundamental analysis prepared by industry experts to forecast future commodity and equity price movements. CDT’s market positions are monitored on a daily basis by the portfolio manager and regular financial reviews of publicly available information related to CDT’s investments are performed to ensure that any risks are within established levels of risk tolerance. The Fund is exposed to price risk through the following financial instrument held by CDT:

2012 2011

Investments at Fair Value held by CDT $ 6,318,377 $ 3,680,648

Based on the above exposure at December 31, 2012, a 10% increase or decrease in the prices of the investments held by CDT would result in a $631,838 (2011 – $368,065) increase or decrease in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant.



5. FINANCIAL RISK MANAGEMENT (CONTINUED)C. FOREIGN EXCHANGE RATE RISK Foreign exchange rate risk describes the impact on the underlying value of financial instruments due to foreign exchange rate movements. The Canadian dollar is the Fund’s and CDT’s functional and reporting currency. Foreign investments, commodities, cash, receivables and payables denominated in foreign currencies are affected by changes in the value of the Canadian dollar compared to foreign currencies. As a result, financial assets may depreciate/appreciate in the short-term due to the strengthening/weakening of the Canadian dollar against other currencies, and the reverse would be true for financial liabilities. The Fund’s exposure to foreign exchange risk relates primarily to CDT’s investment in securities, which are denominated in U.S. dollars. CDT has not hedged its exposure to currency fluctuations, however, it closely monitors relevant foreign exchange currency movements. The Fund is exposed to foreign exchange rate risk through the following financial instruments held by CDT:

2012 2011

Investments at Fair Value held by CDT $ 11,111,859 $ 2,398,073Income and Interest Receivable held by CDT 143,946 36,417

Total Exposure $ 11,255,805 $ 2,434,490

Based on the above exposure at December 31, 2012, a 10% increase or decrease in the Canadian dollar against the U.S. dollar would result in a $1,125,581 (2011 – $243,449) decrease or increase in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant.

D. LIQUIDITY RISKLiquidity risk is defined as the risk that the Fund may not be able to settle or meet its obligations when due. The Fund is exposed to liquidity risk through its monthly and annual redemptions. For the annual redemption, the Fund receives at least 45 days notice prior to the redemption date and has up to 15 business days after the redemption date to settle the redemption. This enables the Manager to sell securities held by CDT and to partially unwind the Forward Agreement. The Forward Agreement terminates on November 28, 2014. The Fund’s other obligations are due within one year. Liquidity risk is managed by investing the majority of CDT’s assets in investments that are traded in an active market and can be readily sold and by partially unwinding the Forward Agreement. The Fund retains sufficient cash and cash equivalent positions to maintain liquidity and comply with liquidity requirements as outlined by securities legislation and its investment policies.

CDT may invest in securities that are not traded on a public stock exchange that may be illiquid. As a result, CDT may not be able to dispose of these investments in a timely manner. CDT mitigates this risk through active management, which involves detailed analysis of such private entities to ensure they are financially sound and would be attractive to potential investors if a sale is necessary. CDT’s investment policies and securities legislation limit the amount invested in illiquid securities and these limits are monitored. As at December 31, 2012 CDT held illiquid securities fair valued at $1,150,593 (2011 – $1,105,000).

E. CREDIT RISK Credit risk represents the financial loss that the Fund would experience if a counterparty to a financial instrument failed to meet its obligations to the Fund. The Fund is exposed to credit risk through the Forward Agreement. The carrying amount of the net assets of CDT underlying the Forward Agreement, as presented on the Statement of Investments, represents the maximum credit risk exposure as at December 31, 2012. The carrying amount of other assets also represents the maximum credit risk exposure, as they will be settled in the short term. As at December 31, 2012, the counterparty to the Forward Agreement had a credit rating of A+ from Standard & Poor’s.



5. FINANCIAL RISK MANAGEMENT (CONTINUED)E. CREDIT RISK (CONTINUED)As at December 31, 2012 and 2011, the Fund had exposure to CDT’s investments in debt instruments and preferred shares, through the Forward Agreement, with the following credit ratings:

Debt Instruments and Preferred As a % of Net Assets of CDT Shares by Credit Rating* 2012 2011

BBB – 37.9%BB 5.2% 2.6%B 11.2% 6.6%CCC 1.6% –No Rating 62.6% 37.2%

* Credit rating from Standard & Poor’s.

6. CAPITAL MANAGEMENT The Fund’s capital is its net assets, representing unitholders’ equity. The Fund’s objective when managing capital is to safeguard the Fund’s ability to continue as a going concern in order to provide returns for unitholders, maximize unitholder value and maintain financial strength.

The Fund manages and adjusts its capital in response to general economic conditions, the risk characteristics of its holdings and working capital requirements. Generally speaking, the Fund will reduce leverage when the investments held by CDT are likely to decrease in value and will increase leverage when investment appreciation is anticipated. Changes in leverage are affected within CDT and transmitted to the Fund via the Forward Agreement.

The Fund is not subject to any externally imposed capital requirements. However, the Fund is subject to covenants in respect of its Forward Agreement and is in compliance with those covenants in both 2012 and 2011. The Fund’s overall strategy with respect to capital risk management remains unchanged from the year ended December 31, 2011.

7. NET ASSETS AND NET ASSET VALUE National Instrument 81-106 “Investment Fund Continuous Disclosure” requires that net asset value for transactional pricing purposes (“Net Asset Value”), be calculated based on the fair value of investments using the close or last trade price. The Canadian Institute of Chartered Accountants Handbook section 3855 “Financial Instruments – Recognition and Measurement” requires that net assets for financial reporting purposes (“Net Assets”), be calculated using the close or last bid price of an investment. Net Assets per share and Net Asset Value per share could be different due to the use of different valuation techniques. The Net Asset Value per unit as at December 31, 2012 was $11.34 (2011 – $11.54) compared to the Net Assets per unit of $11.26 (2011 – $11.47).

8. LOAN PAYABLEThe Forward Agreement enables the Fund to leverage its exposure to CDT by up to 25% of total assets. At December 31, 2012 and 2011, leverage through the Forward Agreement amounted to $15 million. The minimum and maximum leverage outstanding during the years ended December 31, 2012 and 2011 was $15 million for both.

9. FORWARD AGREEMENTOn November 20, 2009 the Fund entered into a Forward Agreement with a Canadian chartered bank (the “Counterparty”) pursuant to which the Fund will acquire, on November 28, 2014, the termination date of the Fund, securities of Canadian public issuers (“Canadian Securities”) having a value based on the economic return provided by the Portfolio. The Portfolio is held by CDT. Under the Forward Agreement, the Counterparty will deliver, on the termination date, Canadian Securities with an aggregate value equal to the redemption proceeds of a corresponding number of units of CDT, net of any amount then owing by the Fund to the Counterparty. The Fund may settle the Forward Agreement in whole or in part prior to the termination date (i) to fund distributions on the units; (ii) to fund redemptions and repurchases of units; (iii) to fund operating expenses and other liabilities, and (iv) for any other reason which the Manager may determine. The Forward Agreement allows the Fund to leverage its exposure to CDT by up to 25% of the assets of the Fund or CDT, as applicable.

Under the Forward Agreement, the Fund is required to pay the Counterparty a fee that ranges between 0.30% and 0.35% per annum of the notional amount of the Forward Agreement. The fee is calculated daily and is payable quarterly in arrears. The Forward Agreement fees for the year ended December 31, 2012 amounted to $373,181 (2011 – $396,515).



9. FORWARD AGREEMENT (CONTINUED)By entering into the Forward Agreement, the Fund is fully exposed to the credit risk associated with the Counterparty, which exposure is determined by reference to the value of the total assets of CDT less its liabilities. The value of the Fund’s Forward Agreement is based on the net assets of CDT, which is determined by valuing the securities of the Portfolio using closing bid prices. The Forward Agreement is valued at fair value, which represents an amount equal to the gain or loss that would be realized if the position was to be closed out in accordance with the terms of the Forward Agreement.

10. MANAGEMENT FEE AND OPERATING EXPENSESThe Manager provides investment and administrative services to the Fund. In consideration for such services the Manager receives a management fee equal to 0.25% per annum of the Net Asset Value (or 0.85% in total when combined with the management fee paid in respect of CDT), calculated and paid monthly in arrears based on the average Net Asset Value of the preceding month. The Manager is reimbursed for reasonable costs related to maintaining the Fund and preparation and distribution of financial statements and other documents to unitholders. The Fund is responsible for the payment of all expenses relating to the operation of the Fund and the carrying on of its business.

11. UNITHOLDERS’ EQUITY The Fund is authorized to issue an unlimited number of transferable, redeemable trust units, each of which represents an equal, undivided interest in the net assets of the Fund. All units have equal rights and privileges.

Unitholders of the Fund can acquire additional units by participating in the Distribution Reinvestment Plan (the “Plan”). The Plan enables unitholders to reinvest their monthly distributions in additional units of the Fund thereby achieving the benefit of compounding returns. The Plan also allows participants to purchase additional units for cash.

The Fund issued 6.2 million combined units at $12.00 per combined unit in 2009. Each combined unit consisted of one unit of the Fund and one unit purchase warrant. The units and warrants comprising the combined units separated in 2009. Units may be surrendered for redemption at any time during the year but at least 10 business days prior to a monthly redemption date and at least 45 days prior to the annual redemption date. During 2012 the Fund redeemed 359,372 units (2011 – 3,554,514), issued 3,507,000 units (2011 – 22,500) and purchased 305,000 units (2011 – 109,000) pursuant to a normal course issuer bid and nil units (2011 – 900) in the market in accordance with the Declaration of Trust. For the year ended December 31, 2012, 11,375 units (2011 – 7,640) were distributed under the Plan, of which 9,143 units (2011 – 2,308) were issued from treasury. Of the units issued in 2012, 3,490,000 units were issued pursuant to a treasury offering which closed on August 31, 2012. The offering raised gross proceeds of $43 million.

The average number of units outstanding during 2012 was 7,353,077 (2011 – 8,144,446). This number was used to calculate the net increase (decrease) in net assets from operations per unit.

12. DISTRIBUTIONSThe Fund pays monthly distributions to unitholders in accordance with its investment objectives. Distributions of the Fund, at the discretion of the unitholder, are reinvested in additional units of the Fund under the Distribution Reinvestment Plan, without sales charge. For the year ended December 31, 2012, distributions amounted to $0.78 per unit (2011 – $0.78).

13. LOSS CARRYFORWARDSAt December 31, 2012 and 2011 the Fund had no capital losses and had non-capital losses of $4,488,376 (2011 – $2,244,770) available for carryforward for tax purposes. The expiry dates of the non-capital losses are as follows:

Expiry Date Amount

December 31, 2029 $ 229,672December 31, 2030 2,015,098December 31, 2032 2,243,606

$ 4,488,376


22 CONVERTIBLE DEBENTURE TRUST

This annual management report of fund performance contains financial highlights and should be read in conjunction with the complete audited annual financial statements of the investment fund that follow this report.

Unitholders may contact us by calling 1-888-890-1868, by writing to us at Middlefield Group at one of the addresses on the back cover or by visiting our website at www.middlefield.com to request a copy of the investment fund’s proxy voting policies and procedures, proxy voting disclosure record or quarterly portfolio disclosure.

Management’s Discussion of Fund Performance

INVESTMENT OBJECTIVE AND STRATEGIESThe investment objective of Convertible Debenture Trust (the “Fund” or “CDT”) is to maximize total returns for unitholders over the life of the Fund. The Fund has been established for the purpose of acquiring and holding a diversified portfolio (the “Portfolio”) comprised primarily of convertible debentures of Canadian issuers. The Portfolio may also include other fixed income and equity securities.

RISK The Fund is exposed to several risks that may affect its performance. The overall risk of the Fund is as described in its prospectus dated October 28, 2009. During 2012, the Fund’s overall risk level may have been impacted as follows:

Market RiskMarket risk describes the Fund’s exposure to volatility in the market value of its underlying securities. Equity markets and commodity prices continued to exhibit volatility in 2012 due to macroeconomic uncertainty and Canadian oil prices traded at an abnormally large discount to American benchmarks due to limited pipeline capacity. The instability in commodity prices and energy pricing differential led to increased market risk. The Fund seeks to mitigate risk through active management, portfolio diversification and through consultation with Groppe, Long & Littell (“Groppe”), an oil and natural gas consulting firm based in Houston, who acts as a Special Advisor to Middlefield Capital Corporation, the advisor to the Fund (“MCC” or the “Advisor”). Groppe provides analysis of the global and political forces impacting the prices of oil and natural gas.

RESULTS OF OPERATIONS Investment Performance The investment portfolio (the “Portfolio”) of the Fund has a significant weighting in convertible debentures. However, to provide further diversification and incremental income, Middlefield Limited (the “Manager”) has added selected dividend-paying equities and high yield corporate bonds to the Portfolio. We continue to focus on the better quality companies that possess high quality assets, low payout ratios, modest levels of third party debt and proven management teams.

The net assets of the Fund increased from $88.9 million at December 31, 2011 to $120.5 million at December 31, 2012 primarily as a result of additional funds received for investment. Net assets on a per unit basis increased from $14.67 at December 31, 2011 to $15.53 at December 31, 2012 due to the appreciation of the investment portfolio of the Fund during 2012.

Revenue and Expenses Revenue for the year ended December 31, 2012 amounted to $5.6 million, a decrease of $0.9 million from the prior year, primarily due to reduced interest earnings on the Fund’s convertible debentures. Expenses for the year decreased by approximately $0.1 million or 11.1% from prior year due to a decrease in average net assets under management in 2012. The management expense ratio (“MER”) amounted to 0.75% in 2012 which was virtually unchanged from 2011. Net investment income decreased by $0.8 million in 2012 and on a per unit basis was unchanged at $0.75.

Trends In 2012, both U.S. and European policy makers struggled to implement reforms aimed at minimizing the economic impact of fiscal imbalances. While volatility is expected to persist in 2013, policy risk has diminished, emerging market inflation has moderated and corporate balance sheets remain strong. U.S. economic growth is accelerating, led by an improved labor market, a recovery in housing and a decline in household leverage. Although Europe will likely experience a recession in 2013, economic growth is expected to resume several quarters thereafter as stress in peripheral countries eventually eases due to lower funding requirements and improved competitiveness. We continue to believe that sustainable long-term global growth will require structural reforms to facilitate deleveraging in developed economies and socio-economic improvements that will increase domestic demand in emerging markets, which remain well supported by accommodative fiscal and monetary policies.



The demand for Canadian high yield debt and convertible bonds remained strong in 2012. A total of $3.1 billion in convertible bonds was raised across 50 new issues, and the overall size of the convertible bond market currently exceeds $14 billion. Similarly, a total of $5.2 billion of new high yield debt was issued across 17 transactions, which increased the size of the high yield debt market to over $13 billion. Looking forward, we expect convertible and high yield bonds to perform well as capital continues to flow into these securities from investors seeking higher yielding investment alternatives.

RELATED PARTY TRANSACTIONS Pursuant to a management agreement, the Manager receives a management fee. For further details please see the “Management Fees” section of this report. MCC, a company under common control with the Manager and Advisor to the Fund, receives advisory fees from the Manager out of the management fee. MCC also receives brokerage commissions from the Fund in connection with securities transactions. All brokerage commissions paid by the Fund were at or below market rates. For further details please see the notes to the financial statements.

MANAGEMENT FEESManagement fees are calculated at 0.60% per annum of the Net Asset Value of the Fund and are split between the Manager and the Advisor. The Manager receives fees for the general administration of the Fund, including maintaining the accounting records, executing securities trades, monitoring compliance with regulatory requirements, and negotiating contractual agreements, among other things. The Advisor receives fees from the Manager for providing investment advice in respect of the Portfolio in accordance with the investment objectives and strategies of the Fund.

RECENT DEVELOPMENTS Future Accounting ChangesInternational Financial Reporting Standards (“IFRS”)Canadian publicly accountable enterprises, which include funds/investment trusts, will be required to prepare financial statements in accordance with IFRS, as issued by the International Accounting Standards Board (“IASB”). On December 12, 2011, the Canadian Accounting Standards Board (“AcSB”) amended the deadline for adoption of IFRS for investment companies to fiscal years beginning on or after January 1, 2014. Accordingly, the Fund will adopt IFRS for its fiscal year beginning January 1, 2014, and will issue its initial financial statements in accordance with IFRS, including comparative information, for the interim period ending June 30, 2014.

The Manager has developed an IFRS changeover plan, which addresses key elements of the conversion to IFRS and has identified the key differences between IFRS and Canadian generally accepted accounting principles (“GAAP”) that are expected to affect the Fund. Elements of the plan include evaluating the impacts of the changeover on all business activities, accounting policies, information technology and data systems, internal controls over financial reporting and disclosure controls and procedures.

Based on the Manager’s current evaluation of the differences between GAAP and IFRS, the adoption of IFRS is not expected to have a significant impact on the calculation of net asset value per unit. IFRS is expected to affect the overall presentation of financial statements and result in additional disclosure in the accompanying notes, particularly in relation to the classification of puttable instruments. Based on initial assessment, the Fund’s units would be classified as a liability under IAS 32 – “Financial Instruments Presentation”. Reclassification of the Fund’s units is not expected to have a material impact on the net asset value per unit on adoption. The Manager continues to monitor changes to IFRS proposed by the IASB and relevant amendments by the AcSB, and the current assessment and IFRS changeover plan may change if new standards are issued or interpretations of existing standards are revised.



FINANCIAL HIGHLIGHTSThe following tables show selected key financial information about the Fund and are intended to help you understand the Fund’s financial performance for the indicated periods. “Net Assets” are calculated in accordance with the Canadian Institute of Chartered Accountants Handbook section 3855 “Financial Instruments – Recognition and Measurement” (“Section 3855”) and are used for financial reporting purposes.

“Net Asset Value” is calculated in accordance with section 14.2 of National Instrument 81-106 “Investment Fund Continuous Disclosure” (“NI 81-106”) and is used for transactional pricing purposes. Section 3855 requires the use of valuation techniques for certain types of investments that may differ from those prescribed by NI 81-106. Ratios and supplemental data are derived from the Fund’s Net Asset Value.

THE FUND’S NET ASSETS PER UNIT (1)

2012 2011 2010 2009(4)

Net Assets, Beginning of Year $ 14.67 $ 14.75 $ 12.20 $ 11.98

INCREASE (DECREASE) FROM OPERATIONS:Total Revenue 0.87 0.86 0.78 0.06Total Expenses (0.12) (0.11) (0.10) (0.02)Realized Gains (Losses) for the Year (0.14) 0.86 0.30 –Unrealized Gains (Losses) for the Year 0.13 (1.41) 1.65 0.20Transaction Costs on Purchase and Sale of Investments (0.01) (0.01) (0.01) (0.01)

TOTAL INCREASE (DECREASE) FROM OPERATIONS (2) 0.86 (0.08) 2.55 0.22

DISTRIBUTIONS:From Income 0.64 0.17 0.47 0.03From Capital Gains – – 0.21 –From Return of Capital – – 1.22 0.15Unit Consolidation (5) (0.64) (0.17) (1.90) (0.18)

TOTAL DISTRIBUTIONS (3) – – – –

Net Assets, End of Year $ 15.53 $ 14.67 $ 14.75 $ 12.20

(1) This information is derived from the Fund’s audited annual financial statements. The Net Assets per unit presented in the financial statements differs from the Net Asset Value calculated for fund pricing purposes. An explanation of these differences can be found in the notes to the financial statements.

(2) Net assets and distributions are based on the actual number of units outstanding at the relevant time. The increase (decrease) from operations is based on the weighted average number of units outstanding over the financial period.

(3) Distributions were reinvested in additional units of the Fund.(4) For the period November 20, 2009 (date of commencement of operations) to December 31, 2009.(5) On December 31 special unit distributions were paid and immediately thereafter the outstanding units of the Fund were consolidated.

RATIOS AND SUPPLEMENTAL DATA 2012 2011 2010 2009(5)

Total Assets (000s) (1) $ 121,284 $ 89,475 $ 143,945 $ 72,296Net Asset Value (000s) (1) $ 121,187 $ 89,390 $ 140,322 $ 69,668Number of Units Outstanding (1) 7,755,316 6,061,134 9,458,100 5,685,358Management Expense Ratio (“MER”) (2) 0.75% 0.74% 0.83% 1.12%MER excluding issuance costs (2) 0.75% 0.74% 0.74% 0.97%Trading Expense Ratio (3) 0.06% 0.09% 0.10% 0.48%Portfolio Turnover Rate (4) 48.98% 35.36% 28.16% –Net Asset Value per Unit $ 15.63 $ 14.75 $ 14.84 $ 12.25

(1) This information is provided as at December 31 of the year shown.(2) The MER is based on total expenses (excluding commissions and other portfolio transaction costs) for the stated period and is expressed

as an annualized percentage of daily average Net Asset Values during the period. The MER excluding issuance costs has been presented separately as it expresses only the ongoing management and administrative expenses as a percentage of average Net Asset Values. Issuance costs are one-time costs incurred at inception.

(3) The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average Net Asset Value during the period.

(4) The Fund’s portfolio turnover rate indicates how actively the Fund’s portfolio investments are managed. A portfolio turnover rate of 100% is equivalent to the Fund buying and selling all of the securities in its portfolio once in the course of the year. The higher the fund’s portfolio turnover rate in a year, the greater the trading costs payable by the fund in the year, and the greater the chance of an investor receiving taxable capital gains in the year. There is not necessarily a relationship between a high turnover rate and the performance of a fund.

(5) For the period November 20, 2009 (date of commencement of operations) to December 31, 2009.



ANNUAL COMPOUND RETURNS Periods Ended December 31, 2012

Since One Year Three Years Inception

Convertible Debenture Trust 5.96% 8.44% 8.90%S&P/TSX Composite Index 7.17% 4.78% 5.23%

The S&P/TSX Composite Index (the “Index”) is comprised of Canadian stocks traded on the Toronto Stock Exchange and is designed to represent the Canadian equity market.

The Fund underperformed the Index in 2012 returning 5.96% compared to the Index total return of 7.17%. Since inception, the Fund has posted an annual compound return of 8.90% compared to the broad equity market which returned 5.23%. The Fund’s strong performance since inception relative to the broad equity market reflects the strength in investor demand for higher yielding securities including convertible debentures issued by Canadian companies.

PAST PERFORMANCEThe performance information shown, which is based on Net Asset Value, assumes that all distributions paid by the Fund in the periods shown were reinvested in additional securities of the Fund. The performance information does not take into account sales, redemption, distribution or other optional charges that would have reduced returns or performance. How the Fund has performed in the past does not necessarily indicate how it will perform in the future.

YEAR-BY-YEAR RETURNSThe bar chart shows how the Fund’s performance has varied from year-to-year for each of the years shown. The return for 2009 is not presented since it relates to a partial period. The chart indicates, in percentage terms, how much an investment made the first day of each financial year would have grown or decreased by the last day of the financial year.

-5

0

5

10

15

20

25

ANNUAL TOTAL RETURNS %

20122010 2011

5.96

21.14

-0.62



Summary of Investment PortfolioAS AT DECEMBER 31, 2012

TOP TWENTY-FIVE HOLDINGS

DESCRIPTION % OF NET ASSET VALUE

1 Lake Shore Gold Corp. 6.25% due September 30, 2017 3.02 Southern Pacific Resource Corp. 6.0% due June 30, 2016 2.93 Uranium One Inc. 5.0% due March 13, 2015 2.54 WesternOne Inc. 8.5% due December 31, 2015 2.55 Parex Resources Inc. 5.25% due June 30, 2016 2.56 Equal Energy Ltd. 6.75% due March 31, 2016 2.57 Advantage Oil & Gas Ltd. 5.0% due January 30, 2015 2.58 Angle Energy Inc. 5.75% due January 31, 2016 2.59 Ag Growth International Inc. 7.0% due December 31, 2014 2.4

10 Chorus Aviation Inc. 9.5% due December 31, 2014 2.311 Dundee Industrial Real Estate Investment Trust 2.312 Arcan Resources Ltd 6.5% due October 31, 2018 2.313 Inmet Mining Corp. 8.75% due June 01, 2020 2.214 Savanna Energy Services Corp. 7.0% due May 25, 2018 2.115 Extendicare Real Estate Investment Trust 6.0% due September 30, 2019 2.116 Gateway Casinos & Entertainment Ltd. 8.875% due November 15, 2017 1.917 Gamehost Inc. 6.25% due July 31, 2015 1.918 Aecon Group Inc. 7.0% due September 30, 2014 1.919 Canexus Corporation 5.75% due December 31, 2018 1.920 Pengrowth Energy Corporation 6.25% due December 31, 2014 1.921 Chemtrade Logistics Income Fund 5.75% due December 31, 2018 1.822 IAMGOLD Corporation 6.75% due October 01, 2020 1.823 Western Energy Services Corp. 7.875% due January 30, 2019 1.824 Newalta Corporation 7.625% due November 23, 2017 1.825 Tricon Capital Group Inc. 6.375% due August 31, 2017 1.7

“Top Twenty-Five Holdings” excludes any temporary cash investments.

ASSET CLASS % OF NET ASSET VALUE

Convertible Debentures 79.9Energy 2.9Real Estate 2.3Preferred Shares 0.9Cash and Short-Term Investments 13.2Other Assets (Liabilities) 0.8

100.0

TOTAL NET ASSET VALUE $ 121,187,441

TOTAL ASSETS $ 121,283,886

The Summary of Investment Portfolio may change over time due to ongoing portfolio transactions. Please visit www.middlefield.com for the most recent quarter-end Summary of Investment Portfolio.


The financial statements of Convertible Debenture Trust (the “Fund”) have been prepared by Middlefield Limited (the “Manager”), the manager of the Fund and approved by the Board of Directors. The Manager is responsible for the information and representations contained in these financial statements and other financial information contained in this annual report.

The Manager maintains appropriate procedures to ensure that relevant and reliable financial information is produced. The financial statements have been prepared in accordance with Canadian generally accepted accounting principles and include certain amounts that are based on estimates and judgements. The significant accounting policies applicable to the Fund are described in the notes to the financial statements.

The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and has reviewed and approved these financial statements.

Deloitte LLP is the external auditor of the Fund. They have audited the financial statements of the Fund in accordance with Canadian generally accepted auditing standards to enable them to express to unitholders their opinion on the financial statements..

Robert F. Lauzon Francisco Z. Ramirez President Senior Vice-President Middlefield Limited and Chief Financial Officer Middlefield Limited March 13, 2013

TO THE UNITHOLDERS OF CONVERTIBLE DEBENTURE TRUSTWe have audited the accompanying financial statements of Convertible Debenture Trust, which comprise the statement of investment portfolio as at December 31, 2012, the statements of net assets as at December 31, 2012 and 2011, and the statements of operations, changes in net assets and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information.

MANAGEMENT’S RESPONSIBILITY FOR THE FINANCIAL STATEMENTSManagement is responsible for the preparation and fair presentation of these financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

AUDITOR’S RESPONSIBILITYOur responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend

on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

OPINIONIn our opinion, the financial statements present fairly, in all material respects, the financial position of Convertible Debenture Trust as at December 31, 2012 and 2011, and the results of its operations, changes in its net assets and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Chartered Professional Accountants, Chartered Accountants Licensed Public Accountants Toronto, Ontario

March 13, 2013

INDEPENDENT AUDITOR’S REPORT

MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING



STATEMENTS OF NET ASSETSAS AT DECEMBER 31 2012 2011

ASSETS:Investments at Fair Value $ 103,463,640 $ 78,618,535Cash 15,961,181 8,683,135Income and Interest Receivable 1,124,974 1,711,018Accounts Receivable – 7,700

120,549,795 89,020,388

LIABILITIES:Accounts Payable and Accrued Liabilities 96,445 84,502

Net Assets $ 120,453,350 $ 88,935,886

Units Issued and Outstanding (Note 9) 7,755,316 6,061,134

Net Assets per Unit (Note 7) $ 15.53 $ 14.67 Approved by the Board of Directors of Middlefield Limited, as Manager:

Director: Robert F. Lauzon Director: Francisco Z. Ramirez

STATEMENTS OF OPERATIONSFOR THE YEARS ENDED DECEMBER 31 2012 2011

INVESTMENT INCOME:Interest $ 5,154,777 $ 6,032,200Income from Investments 438,270 439,452

5,593,047 6,471,652

EXPENSES (Note 8):Management Fee 628,908 713,979Unitholder Reporting Costs 54,282 50,264Fund Administration 35,143 36,189Independent Review Committee Fees 10,500 8,000Custodial Fees 9,634 11,317Audit Fees 7,489 13,254Director Fees 1,064 2,643Legal 609 4,957

747,629 840,603

Net Investment Income 4,845,418 5,631,049

NET GAIN (LOSS) ON INVESTMENTS AND TRANSACTION COSTS:Net Realized Gain (Loss) from Investment Transactions (852,310) 6,552,775Net Realized Loss on Foreign Currency Transactions (62,475) (12,667)Change in Net Unrealized Gain (Loss) on Investments 843,646 (10,661,414)Transaction Costs on Purchase and Sale of Investments (Note 11) (62,222) (105,109)

Net Loss on Investments and Transaction Costs (133,361) (4,226,415)

Net Increase in Net Assets from Operations $ 4,712,057 $ 1,404,634

Net Increase in Net Assets from Operations per Unit (Note 9) $ 0.73 $ 0.19




STATEMENTS OF CHANGES IN NET ASSETSFOR THE YEARS ENDED DECEMBER 31 2012 2011

Net Assets at Beginning of Year $ 88,935,886 $ 139,531,268

OPERATIONS:Net Increase in Net Assets from Operations 4,712,057 1,404,634

DISTRIBUTIONS TO UNITHOLDERS:From Net Investment Income (4,988,682) (1,006,982)

UNITHOLDER TRANSACTIONS:Proceeds from Issue of Trust Units, Net 38,805,432 –Reinvested Distributions 4,988,682 1,006,982Payment on Redemption of Trust Units (12,000,025) (52,000,016)

31,794,089 (50,993,034)

Net Increase (Decrease) in Net Assets 31,517,464 (50,595,382)

Net Assets at End of Year $ 120,453,350 $ 88,935,886

Total Assets $ 120,549,795 $ 89,020,388

Distributions per Unit (Note 10) $ 0.64 $ 0.17

STATEMENTS OF CASH FLOWSFOR THE YEARS ENDED DECEMBER 31 2012 2011

OPERATING ACTIVITIES:Net Increase in Net Assets from Operations $ 4,712,057 $ 1,404,634Adjustments: Purchase of Investments (65,694,881) (36,765,516) Proceeds from Disposition of Investments 40,778,637 87,101,739 Net Realized (Gain) Loss from Investment Transactions 852,310 (6,552,775) Net Realized Loss on Foreign Currency Transactions 62,475 12,667 Change in Net Unrealized (Gain) Loss on Investments (843,646) 10,661,414

(20,133,048) 55,862,163Net Change in Non-Cash Working Capital 605,687 (4,416,078)

(19,527,361) 51,446,085

FINANCING ACTIVITIES:Proceeds from Issue of Trust Units, Net 38,805,432 –Payment on Redemption of Trust Units (12,000,025) (52,000,016)

26,805,407 (52,000,016)

Net Increase (Decrease) in Cash 7,278,046 (553,931)Cash at Beginning of Year 8,683,135 9,237,066

Cash at End of Year $ 15,961,181 $ 8,683,135




STATEMENT OF INVESTMENT PORTFOLIOAS AT DECEMBER 31, 2012


Advantage Oil & Gas Ltd. 5.0% due January 30, 2015 3,000,000 $ 3,043,277 $ 2,985,000Aecon Group Inc. 7.0% due September 30, 2014 2,250,000 2,354,060 2,340,000Ag Growth International Inc. 7.0% due December 31, 2014 2,750,000 2,856,855 2,853,125Allied Nevada Gold Corp. 8.75% due June 01, 2019 975,000 963,865 1,016,438Anderson Energy Ltd. 7.50% due January 31, 2016 2,200,000 2,200,000 1,397,000Angle Energy Inc. 5.75% due January 31, 2016 3,000,000 2,940,566 2,970,000Arcan Resources Ltd. 6.50% due October 31, 2018 3,100,000 2,934,483 2,635,000Arcan Resources Ltd. 6.25% due February 28, 2016 250,000 180,699 218,125Bellatrix Exploration Ltd. 4.75% due April 30, 2015 1,500,000 1,516,875 1,558,500C2C Industrial Properties Inc. 6.75% due November 30, 2017 1,250,000 1,250,000 1,225,000Canexus Corporation 5.75% due December 31, 2018 2,250,000 2,325,884 2,310,750Capstone Infrastructure Corporation 6.50% due December 31, 2016 350,000 362,501 363,650Celtic Exploration Ltd. 5.0% due April 30, 2017 1,000,000 1,000,000 1,340,100Centric Health Corporation 6.75% due October 31, 2017 1,250,000 1,250,000 1,002,500Chartwell Seniors Housing Real Estate Investment Trust 5.70% due March 31, 2018 850,000 916,105 915,875Chemtrade Logistics Income Fund 5.75% due December 31, 2018 2,150,000 1,999,500 2,213,855Chorus Aviation Inc. 9.50% due December 31, 2014 2,750,000 2,801,075 2,825,625Detour Gold Corporation 5.50% due November 30, 2017 1,500,000 1,512,005 1,578,493Equal Energy Ltd. 6.75% due March 31, 2016 3,000,000 2,981,145 2,985,000Estrella International Energy Services Ltd. 12.0% due December 31, 2015 533,650 533,650 453,603Extendicare Inc. 6.0% due September 30, 2019 2,500,000 2,500,000 2,556,250First Capital Realty Inc. 5.25% due January 31, 2019 684,000 697,045 697,680Fortress Paper Ltd. 7.0% due December 31, 2019 1,000,000 1,000,000 713,500Gamehost Inc. 6.25% due July 31, 2015 2,000,000 1,929,400 2,336,200Gateway Casinos & Entertainment Ltd. 8.875% due November 15, 2017 2,250,000 2,320,000 2,362,500HudBay Minerals Inc 9.50% due October 01, 2020 750,000 766,022 789,713IAMGOLD Corporation 6.75% due October 01, 2020 2,250,000 2,161,634 2,184,314Inmet Mining Corp. 8.75% due June 01, 2020 2,500,000 2,524,790 2,712,806InnVest Real Estate Investment Trust 5.85% due August 01, 2014 750,000 710,935 750,000InnVest Real Estate Investment Trust 6.0% due September 30, 2017 2,000,000 2,007,500 1,942,200InnVest Real Estate Investment Trust 5.75% due March 30, 2018 850,000 821,494 816,000Just Energy Group Inc. 6.00% due June 30, 2017 1,000,000 988,352 822,500Killam Properties Inc. 5.65% due November 30, 2017 1,250,000 1,251,590 1,328,750Kirkland Lake Gold Inc 7.50% due December 31, 2017 400,000 400,000 400,000Lake Shore Gold Corp. 6.25% due September 30, 2017 4,000,000 4,000,000 3,648,000Lone Pine Resources Ltd. 10.375% due February 15, 2017 500,000 501,827 467,978Minexco Petroleum Inc. 7.0% due November 29, 2017 700,000 694,893 696,990New Gold Inc. 7.0% due April 15, 2020 1,000,000 1,006,447 1,025,570Newalta Corporation 7.625% due November 23, 2017 2,000,000 2,043,750 2,148,750Niko Resources Ltd 7.0% due December 31, 2017 800,000 803,783 880,000North American Palladium Ltd. 6.15% due September 30, 2017 750,000 713,438 597,000




STATEMENT OF INVESTMENT PORTFOLIO (CONTINUED)AS AT DECEMBER 31, 2012


Paladin Energy Ltd. 6.0% due April 30, 2017 1,850,000 $ 1,806,781 $ 1,655,996Paramount Resources Ltd. 8.25% due December 13, 2017 2,000,000 2,000,000 2,070,764Parex Resources Inc. 5.25% due June 30, 2016 3,000,000 2,986,508 2,985,000Pengrowth Energy Corporation 6.25% due December 31, 2014 2,250,000 2,250,000 2,295,000Perpetual Energy Inc. 7.25% due January 31, 2015 500,000 487,005 472,500Perpetual Energy Inc. 7.00% due December 31, 2015 750,000 702,322 705,000Perpetual Energy Inc. 8.75% due March 15, 2018 1,500,000 1,305,000 1,447,500Savanna Energy Services Corp. 7.0% due May 25, 2018 2,500,000 2,532,500 2,558,333Sherritt International Corporation 7.50% due September 24, 2020 750,000 750,000 768,430Southern Pacific Resource Corp. 6.0% due June 30, 2016 3,500,000 3,583,097 3,538,500Superior Plus Corp. 7.50% due December 31, 2014 750,000 780,188 776,250TransGlobe Energy Corporation 6.0% due March 31, 2017 1,500,000 1,519,375 1,507,500Tricon Capital Group Inc. 6.375% due August 31, 2017 1,850,000 1,885,163 2,053,500Uranium One Inc. 5.0% due March 13, 2015 3,000,000 3,047,500 3,045,000Western Energy Services Corp. 7.875% due January 30, 2019 2,100,000 2,128,500 2,168,250WesternOne Inc. 8.50% due December 31, 2015 2,000,000 2,000,000 2,981,000

CONVERTIBLE DEBENTURES: 80.5% 95,529,384 96,092,863

Birchcliff Energy Ltd. – Warrants, $8.30, August 8, 2014 120,000 – 168,000Estrella International Energy Services Ltd. – Warrants, $0.80, March 3, 2015 13 – 2,401Freehold Royalties Ltd. 75,000 1,113,734 1,670,250Gibson Energy Inc. 70,000 1,449,000 1,677,900

ENERGY: 2.9% 2,562,734 3,518,551

Dundee Industrial Real Estate Investment Trust 250,000 2,477,520 2,787,500First Capital Realty Inc. 656 12,114 12,326

REAL ESTATE: 2.3% 2,489,634 2,799,826

Birchcliff Energy Ltd. 8.0% Preferred due September 30, 2017 40,000 1,000,000 1,052,400

PREFERRED SHARES: 0.9% 1,000,000 1,052,400

EMBEDDED BROKER COMMISSIONS (Note 11) (56,323) –

TOTAL INVESTMENTS: 86.6% 101,525,429 103,463,640CASH: 13.4% 15,961,181 15,961,181

Total Investment Portfolio, including Cash $ 117,486,610 $ 119,424,821




1. CONVERTIBLE DEBENTURE TRUSTConvertible Debenture Trust (the “Fund”) is a closed-end investment trust established under the laws of the Province of Alberta on October 28, 2009. The Fund effectively commenced operations on November 20, 2009 when it first issued units on an exempt basis. Middlefield Limited (the “Manager”), a company incorporated in Alberta, is both the manager and trustee of the Fund. Middlefield Capital Corporation (“MCC” or the “Advisor”), a company under common control with the Manager, is the advisor to the Fund.

2. INVESTMENT OBJECTIVE AND STRATEGYThe Fund’s investment objective is to maximize total returns for unitholders over the life of the Fund. The Fund has been established for the purpose of acquiring and holding a diversified portfolio (the “Portfolio”) comprised primarily of convertible debentures of Canadian issuers. The Portfolio may also include other fixed income and equity securities.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. FUTURE ACCOUNTING CHANGESInternational Financial Reporting Standards (“IFRS”)Canadian publicly accountable enterprises, which include funds/investment trusts, will be required to prepare financial statements in accordance with IFRS, as issued by the International Accounting Standards Board. On December 12, 2011, the Canadian Accounting Standards Board amended the deadline for adoption of IFRS for investment companies to fiscal years beginning on or after January 1, 2014. Accordingly, the Fund will adopt IFRS for its fiscal year beginning January 1, 2014, and will issue its initial financial statements in accordance with IFRS, including comparative information, for the interim period ending June 30, 2014.

B. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTSThe Fund’s own credit risk and the credit risk of the counterparty is taken into account in determining the fair value of financial assets and financial liabilities, including derivative instruments. Management has reviewed its policies concerning valuation of assets and liabilities and determined that the fair values ascribed to the financial assets and financial liabilities in the Fund’s financial statements incorporate appropriate levels of credit risk.

C. INVESTMENTS AT FAIR VALUE Securities listed on a recognized public stock exchange are valued at their closing bid price on the valuation date. Securities with no available bid price are valued at their closing trade price. Securities not listed on a recognized public stock exchange are valued based on recent transactions between willing parties, if such information is available, or alternatively valued using valuation techniques which may include the use of the operating results of the investees, expected future cash flows discounted at appropriate discount rates and comparable peer group valuations adjusted for company specific circumstances. Bonds and debentures are valued at their closing bid price on the valuation date.

D. INVESTMENT TRANSACTIONS AND INCOME RECOGNITIONInvestment transactions are accounted for as of the trade date and any realized gains or losses from such transactions are calculated on an average cost basis. The change in the difference between fair value and average cost of the investments is recorded as unrealized gain (loss) on investments. Income from investments is recognized on the ex-dividend or ex-distribution date. Interest income is recognized on an accrual basis.

E. NET INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS PER UNITNet increase (decrease) in net assets from operations per unit in the Statements of Operations represents the increase (decrease) in net assets from operations divided by the average units outstanding during the year.

F. INCOME TAXESThe Fund is a financial institution for purposes of the “mark-to-market” rules of the Income Tax Act (Canada) (the “Tax Act”). Under the terms of the Declaration of Trust, any taxable income of the Fund is distributable to unitholders of record date. The Fund is not subject to tax on the income distributed to unitholders. Accordingly, no provision for income taxes is required.



3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)G. RETURN OF CAPITALDistributions received from investment trust units that are treated as a return of capital for tax purposes are used to reduce the average cost of the underlying investments on the Statement of Investment Portfolio.

H. FOREIGN CURRENCY TRANSLATIONForeign currency amounts are translated into Canadian dollars as follows: currency conversions are made at the appropriate daily U.S. dollar noon rate as quoted by the Bank of Canada. Revenue and expenses and investment transactions in currencies other than Canadian dollars are translated into Canadian dollars at the rate of exchange prevailing on the date of such transactions. Investments in securities at fair value, other assets and liabilities in foreign currencies are translated into Canadian dollars at the rate of exchange prevailing at year end.

I. FINANCIAL INSTRUMENTSThe carrying values of financial instruments, including cash, receivables, payables and accruals approximate the fair value due to their short maturities.

J. USE OF ESTIMATESThe preparation of financial statements in accordance with Canadian generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the financial statements and the increase and decrease in net assets from operations during the reporting period. The most significant estimates and assumptions relate to the valuation of illiquid securities. Actual results could differ from those estimates.

4. FAIR VALUE DISCLOSUREThe tables below summarize the fair value of the Fund’s financial instruments as at December 31, 2012 and 2011 using the following fair value hierarchy:

Level 1 Inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2 Inputs other than quoted prices that are observable for the asset or liability either directly or indirectly, including inputs in markets that are not considered to be active.

Level 3 Inputs that are unobservable and where there is little, if any, market activity. Inputs into the determination of fair value require significant management judgment or estimation.

As at December 31, 2012Description Level 1 Level 2 Level 3 Total

Cash $ 15,961,181 $ – $ – $ 15,961,181Convertible Debentures 71,642,431 23,299,839 1,150,593 96,092,863Common Shares 3,360,476 – – 3,360,476Preferred Shares 1,052,400 – – 1,052,400Trust Units 2,787,500 – – 2,787,500Warrants 168,000 2,401 – 170,401

Total $ 94,971,988 $ 23,302,240 $ 1,150,593 $ 119,424,821

As at December 31, 2011 Description Level 1 Level 2 Level 3 Total

Cash $ 8,683,135 $ – $ – $ 8,683,135Convertible Debentures 64,163,129 9,669,758 1,105,000 74,937,887Common Shares 3,666,257 – – 3,666,257Warrants – 14,391 – 14,391

Total $ 76,512,521 $ 9,684,149 $ 1,105,000 $ 87,301,670

No transfers between levels have occurred during the years ended December 31, 2012 and 2011.



4. FAIR VALUE DISCLOSURE (CONTINUED)The reconciliations of investments measured at fair value using unobservable inputs (Level 3) for the years ended December 31, 2012 and 2011 are presented as follows:

2012

Balance at January 1, 2012 $ 1,105,000Purchases 694,893Proceeds from Sales (651,397)Realized Losses (114,953)Change in Unrealized Gain 117,050


Total Change in Unrealized Gain during the Year for Assets held at December 31, 2012 $ 2,097

2011

Balance at January 1, 2011 $ –Purchases 1,300,000Change in Unrealized Loss (195,000)


Total Change in Unrealized Loss during the Year for Assets held at December 31, 2011 $ 195,000

The use of reasonable possible alternative assumptions for valuing Level 3 financial instruments would not significantly affect the fair value of those instruments.

5. FINANCIAL RISK MANAGEMENTIn the normal course of business the Fund is exposed to a variety of financial risks: interest rate risk, price risk, foreign exchange rate risk, liquidity risk and credit risk. The Fund’s primary risk management objective is to protect earnings and cash flow and, ultimately, unitholder value. Risk management strategies, as discussed below, are designed and implemented to ensure the Fund’s risks and related exposures are consistent with its objectives and risk tolerance.

Most of the Fund’s risks are derived from its investments. The value of the investments within the Fund portfolio can fluctuate on a daily basis as a result of changes in interest rates, economic conditions, commodity prices, the market and company news related to specific securities within the Fund. The investments are made in accordance with the Fund’s risk management policies. The policies establish investment objectives, strategies, criteria and restrictions. The objectives of these policies are to identify and mitigate investment risk through a disciplined investment process and the appropriate structuring of each transaction.

A. INTEREST RATE RISK Interest rate risk describes the Fund’s exposure to changes in the general level of interest rates. Interest rate risk arises when the Fund invests in interest-bearing financial assets such as cash and debt securities. The earnings of the Fund are positively correlated to interest rates as relates to interest on cash balances. Rising interest rates serve to increase the Fund’s earnings while the reverse is true in a declining interest rate environment. The Fund is also exposed to the risk that the value of its financial assets, such as convertible debentures, will fluctuate due to changes in the prevailing levels of market interest rates. The value of such financial assets is negatively correlated to interest rates. The Fund seeks to mitigate this risk through active management, which involves analysis of economic indicators to forecast Canadian and global interest rates. The tables below summarize the Fund’s exposure to interest rate risk by remaining term to maturity as at December 31, 2012 and 2011.



5. FINANCIAL RISK MANAGEMENT (CONTINUED)A. INTEREST RATE RISK (CONTINUED)


Convertible Debentures $ – $ 68,562,599 $ 27,530,264 $ 96,092,863Preferred Shares – 1,052,400 – 1,052,400Cash 15,961,181 – – 15,961,181

Total Exposure $ 15,961,181 $ 69,614,999 $ 27,530,264 $ 113,106,444


Convertible Debentures $ 6,922,250 $ 44,852,880 $ 23,162,757 $ 74,937,887Cash 8,683,135 – – 8,683,135

Total Exposure $ 15,605,385 $ 44,852,880 $ 23,162,757 $ 83,621,022

Based on the above exposure at December 31, 2012, a 1% per annum increase or decrease in interest rates would result in a $3,119,093 (December 31, 2011 – $2,334,430) decrease or increase in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant.

B. PRICE RISKPrice risk is the risk that changes in the prices of the Fund’s investments will affect the Fund’s income or the value of its financial instruments. The Fund’s price risk is driven primarily by volatility in commodity and equity prices. Rising commodity and equity prices may increase the price of an investment while declining commodity and equity prices may have the opposite effect. The Fund mitigates price risk by making investing decisions based upon various factors, including comprehensive fundamental analysis prepared by industry experts to forecast future commodity and equity price movements. The Fund’s market positions are monitored on a daily basis by the portfolio manager and regular financial reviews of publicly available information related to the Fund’s investments are performed to ensure that any risks are within established levels of risk tolerance. The Fund is exposed to price risk through the following financial instrument:

2012 2011

Investments at Fair Value $ 6,318,377 $ 3,680,648

Based on the above exposure at December 31, 2012, a 10% increase or decrease in the prices of the Fund’s investments would result in a $631,838 (2011 – $368,065) increase or decrease in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant.

C. FOREIGN EXCHANGE RATE RISK Foreign exchange rate risk describes the impact on the underlying value of financial instruments due to foreign exchange rate movements. The Canadian dollar is the Fund’s functional and reporting currency. Foreign investments, commodities, cash, receivables and payables denominated in foreign currencies are affected by changes in the value of the Canadian dollar compared to foreign currencies. As a result, financial assets may depreciate/appreciate in the short-term due to the strengthening/weakening of the Canadian dollar against other currencies, and the reverse would be true for financial liabilities. The Fund’s exposure to foreign exchange risk relates primarily to its investment in securities, which are denominated in U.S. dollars. The Fund has not hedged its exposure to currency fluctuations, however, it closely monitors relevant foreign exchange currency movements. The Fund is exposed to foreign exchange rate risk through the following financial instruments:



5. FINANCIAL RISK MANAGEMENT (CONTINUED)C. FOREIGN EXCHANGE RATE RISK (CONTINUED)

2012 2011

Investments at Fair Value $ 11,111,859 $ 2,398,073Income and Interest Receivable 143,946 36,417

Total Exposure $ 11,255,805 $ 2,434,490

Based on the above exposure at December 31, 2012, a 10% increase or decrease in the Canadian dollar against the U.S. dollar would result in a $1,125,581 (2011 – $243,449) decrease or increase in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant.

D. LIQUIDITY RISKLiquidity risk is defined as the risk that the Fund may not be able to settle or meet its obligations when due. The Fund is exposed to liquidity risk through its redemptions. The Fund’s other obligations are due within one year. Liquidity risk is managed by investing the majority of the Fund’s assets in investments that are traded in an active market and can be readily sold. The Fund retains sufficient cash to maintain liquidity and comply with liquidity requirements as outlined by securities legislation and its investment policies.

The Fund may invest in securities that are not traded on a public stock exchange that may be illiquid. As a result, the Fund may not be able to dispose of these investments in a timely manner. The Fund mitigates this risk through active management, which involves detailed analysis of such private entities to ensure they are financially sound and would be attractive to potential investors if a sale is necessary. The Fund’s investment policies and securities legislation limit the amount invested in illiquid securities and these limits are monitored. As at December 31, 2012 the Fund held illiquid securities fair valued at $1,150,593 (2011 – $1,105,000).

E. CREDIT RISK Credit risk represents the financial loss that the Fund would experience if a counterparty to a financial instrument failed to meet its obligations to the Fund. The carrying amounts of financial assets represent the maximum credit risk exposure. All transactions executed by the Fund in listed securities are settled upon delivery using approved brokers. The risk of default is considered minimal, as delivery of securities sold is only made once the broker has received payment. Payment is made on a purchase only once the broker has received the securities. The trade will fail if either party fails to meet its obligations. There is no significant credit risk related to the Fund’s other receivables.

The Fund’s credit risk is primarily attributable to its investment in debt instruments because the issuer of the instrument may be unable to make interest payments or repay the principal amount on maturity. The concentration of credit risk of investments in debt instruments is minimal since the Fund invests in a variety of debt instruments issued by numerous issuers.

The Fund has established various internal controls to help mitigate credit risk, including prior approval of all investments by the Advisor whose mandate includes conducting financial and other assessments of these investments on a regular basis. The Fund has also implemented policies which ensure that investments can only be made with counterparties that have a minimum acceptable credit rating.

As at December 31, 2012 and 2011 the Fund invested in debt instruments and preferred shares with the following credit ratings:

Debt Instruments and Preferred As a % of Net Assets Shares by Credit Rating* 2012 2011

BBB – 37.9%BB 5.2% 2.6%B 11.2% 6.6%CCC 1.6% –No Rating 62.6% 37.2%

* Credit rating from Standard & Poor’s.



6. CAPITAL MANAGEMENT The Fund’s capital is its net assets, representing unitholders’ equity. The Fund’s objective when managing capital is to safeguard the Fund’s ability to continue as a going concern in order to provide returns for unitholders, maximize unitholder value and maintain financial strength. The Fund manages its capital by taking into consideration the risk characteristics of its holdings. The Fund is not subject to any externally imposed capital requirements.

7. NET ASSETS AND NET ASSET VALUE National Instrument 81-106 “Investment Fund Continuous Disclosure” requires that net asset value for transactional pricing purposes (“Net Asset Value”), be calculated based on the fair value of investments using the close or last trade price. The Canadian Institute of Chartered Accountants Handbook section 3855 “Financial Instruments – Recognition and Measurement” requires that net assets for financial reporting purposes (“Net Assets”), be calculated using the close or last bid price of an investment. Net Assets per share and Net Asset Value per share could be different due to the use of different valuation techniques. The Net Asset Value per unit as at December 31, 2012 was $15.63 (2011 – $14.75) compared to the Net Assets per unit of $15.53 (2011 – $14.67).

8. MANAGEMENT FEE AND OPERATING EXPENSESThe Manager provides investment and administrative services to the Fund. In consideration for such services the Manager receives a management fee equal to 0.60% per annum of the Net Asset Value, calculated and paid monthly in arrears based on the average Net Asset Value of the preceding month. The Manager is reimbursed for reasonable costs related to maintaining the Fund and preparation and distribution of financial statements and other documents to unitholders. The Fund is responsible for the payment of all expenses relating to the operation of the Fund and the carrying on of its business.

9. UNITHOLDERS’ EQUITYThe Fund is authorized to issue an unlimited number of a single class of transferable, redeemable units of beneficial interest, each of which represents an equal, undivided interest in the net assets of the Fund.

The Fund issued 5,540,250 units at $12.00 per unit and 145,108 units at $11.98 per unit in 2009. Units may be surrendered for redemption at any time during the year but at least four business days prior to a redemption date. During 2012, the Fund redeemed 784,970 units (2011 – 3,396,966) and issued 2,479,152 units (2011 – nil).

The average number of units outstanding during 2012 was 6,457,892 (2011 – 7,566,485). This number was used to calculate the net increase (decrease) in net assets from operations per unit.

10. DISTRIBUTIONSThe Fund may pay distributions if, as and when declared, from time to time. The Fund pays distributions in units, with subsequent consolidation, to ensure it is not liable for tax under the Tax Act. For the year ended December 31, 2012, distributions paid in units, with subsequent consolidation, amounted to $0.64 per unit (2011 – $0.17).

11. TRANSACTION COSTSBrokerage commissions and other transaction costs paid in connection with securities transactions during 2012 amounted to $62,222 (2011 – $105,109). Included in this amount is $2,965 (2011 – $25,455) in brokerage commissions that were paid to MCC. All commissions paid by the Fund were at or below market rates. Brokerage commissions and other transaction costs are expensed and recorded in the Statements of Operations.

12. LOSS CARRYFORWARDSAt December 31, 2012 and 2011 the Fund did not have any capital or non-capital losses for carryforward for tax purposes.

13. COMPARATIVE FINANCIAL STATEMENTSCertain prior year balances in the Statements of Cash Flows have been reclassified to conform with the current year presentation.


DISTRIBUTIONS (PER UNIT)

2009

31-Dec $ 0.065

2010

31-Jan $ 0.065 30-Apr $ 0.065 31-Jul $ 0.065 31-Oct $ 0.06529-Feb 0.065 31-May 0.065 31-Aug 0.065 30-Nov 0.06531-Mar 0.065 30-Jun 0.065 30-Sep 0.065 31-Dec 0.065

2011


2012


2013

31-Jan $ 0.06528-Feb 0.065

DISTRIBUTION REINVESTMENT PLAN:For information regarding the Distribution Reinvestment Plan, please contact our Investor Relations department, our Transfer Agent or visit our website at www.middlefield.com.

You may voluntarily terminate your participation in the Plan and elect to receive cash instead of Plan units, by delivering to the Plan Agent (or, if you are a beneficial owner of units, by having your broker or other nominee deliver to the Plan Agent (through CDS & Co., if applicable) on your behalf) a written notice of termination signed by you or your broker or other nominee, as applicable.


TAX INFORMATION (PER UNIT)Pathfinder Convertible Debenture Fund will be issuing T3 Supplementary slips to registered Unitholders by April 1, 2013. The following table outlines the allocation of the 2012 distribution for each Unit.

Allocation

Distribution Return ofRecord Date Payable Date Per Unit Capital

January 31, 2012 February 15, 2012 0.065000 0.065000February 29, 2012 March 15, 2012 0.065000 0.065000March 31, 2012 April 13, 2012 0.065000 0.065000April 30, 2012 May 15, 2012 0.065000 0.065000May 31, 2012 June 15, 2012 0.065000 0.065000June 30, 2012 July 13, 2012 0.065000 0.065000July 31, 2012 August 15, 2012 0.065000 0.065000August 31, 2012 September 14, 2012 0.065000 0.065000September 30, 2012 October 15, 2012 0.065000 0.065000October 31, 2012 November 15, 2012 0.065000 0.065000November 30, 2012 December 14, 2012 0.065000 0.065000December 31, 2012 January 15, 2013 0.065000 0.065000

TOTAL 0.780000 0.780000

100.00% 100.00%

Holders of Units outside of an RRSP, RRIF or DPSP should have received a T3 tax slip from their investment dealer. T3 tax slips report Capital Gains in Box 21, Other Income in Box 26, Return of Capital in Box 42 and Eligible Dividends in Box 49. Eligible dividends are subject to the gross-up and federal dividend tax credit rules. The Return of Capital component of the distribution is a non-taxable amount that should be deducted from the adjusted cost base of the Units.

2012 TAX INFORMATION


Middlefield FUNDS FAMILYTSX-LISTED FUNDS TSX Stock Symbol

ACTIVEnergy Income Fund AEU.UN COMPASS Income Fund CMZ.UN ENERGY INDEXPLUS Dividend Fund IDE.UN Global Dividend Growers Income Fund (commenced March 2013) GDG.UN INDEXPLUS Income Fund IDX.UN MBN Corporation MBN Middlefield Canadian Income PCC LSE Symbol:MCT Middlefield Can-Global REIT Income Fund RCO.UN Middlefield Income Plus II Corp. MIP MINT Income Fund MID.UN Pathfinder Convertible Debenture Fund PCD.UN REIT INDEXPLUS Income Fund IDR.UN Uranium Focused Energy Fund UF.UN YIELDPLUS Income Fund YP.UN

MUTUAL FUNDS Fund CodeSeries A Shares FE/LL/DSC

ActiveIndex REIT Class MID 600/649/650 Groppe Tactical Energy Class MID 125/127/130 Middlefield Canadian Dividend Growth Class (formerly Middlefield Canadian Growth Class) MID 148/449/450 Middlefield Global Agriculture Class MID 161/163/166 Middlefield Canadian High Yield Class (formerly Middlefield Income and Growth Class) MID 300/349/350 Middlefield Income Plus Class MID 800/849/850 Middlefield Precious Metals Class MID 170/174/175 Middlefield Short-Term Income Class MID 400/424/425 Middlefield Uranium Focused Metals Class MID 210/219/220

Series F Shares

ActiveIndex REIT Class MID 601 Groppe Tactical Energy Class MID 126 Middlefield Canadian Dividend Growth Class (formerly Middlefield Canadian Growth Class) MID 149 Middlefield Global Agriculture Class MID 162 Middlefield Canadian High Yield Class (formerly Middlefield Income and Growth Class) MID 301 Middlefield Income Plus Class MID 801 Middlefield Precious Metals Class MID 171

RESOURCE FUNDS

MRF 2012 Resource Limited Partnership MRF 2013 Resource Limited Partnership (commenced February 2013)

Discovery 2011 Flow-Through Limited Partnership Discovery 2012 Flow-Through Limited Partnership


CORPORATE INFORMATION

DirectorsMurray J. Brasseur Chairman Middlefield Group

Dennis da Silva Managing Director Resource Group Middlefield Capital Corporation

Richard L. Faiella, CFAManaging Director Corporate Development Middlefield International Limited

W. Garth Jestley, CFA Deputy Chairman Middlefield International Limited

Robert F. Lauzon, CFAManaging Director Western Canada Middlefield Capital Corporation

Dean Orrico President and Chief Executive Officer Middlefield Capital Corporation

Sylvia V. StinsonExecutive Vice-President and Chief Financial Officer Middlefield Group

Independent Review CommitteeGeorge S. Dembroski Former Vice-Chairman RBC Dominion Securities Limited

H. Roger GarlandFormer Vice-Chairman Four Seasons Hotels Inc.

Bernard I. Ghert (Chairman)Former Chairman Mount Sinai Hospital

Charles B. Young Former Deputy Chairman Canary Wharf

AdvisorsGroppe, Long & Littell Guardian Capital LP Middlefield Capital Corporation

OfficersHenry LeePresident Middlefield Realty Services Limited

Nick LombardiPresident MF Properties Limited

Jeremy T. BrasseurManaging Director Corporate Development Middlefield Capital Corporation

Nancy ThamManaging Director Sales and Marketing Middlefield Capital Corporation

Andy NasrExecutive Director, Corporate Development and Portfolio Management Middlefield Capital Corporation

Michael BuryDirector, Sales and Marketing Middlefield Capital Corporation

Douglas D. SedoreDirector Horizon on Bay Limited

Michael T. KimedaSenior Vice-President and Chief Financial Officer Middlefield Capital Corporation

J. Dennis DunlopSenior Vice-President Middlefield Group

Maria F. HerreraSenior Vice-President Middlefield Group

Dinah MasonSenior Vice-President Horizon on Bay Limited

Francis RamirezSenior Vice-President and Chief Compliance Officer Middlefield Capital Corporation

Polly TseSenior Vice-President and Chief Financial Officer MFL Management Limited

Nicole S. BrasseurVice-President Middlefield Group

Stephen ChamberlainVice-President Middlefield Realty Services Limited

Stacy J. CrestohlVice-President Middlefield Group

Shiranee GomezVice-President Middlefield Group

Vincenzo GrecoVice-President Middlefield Limited

Terry LandriaultVice-President Middlefield Group

Judy MarksVice-President Middlefield Group

Lilibeth MondejarVice-President Horizon on Bay Limited

Victor NgaiVice-President Middlefield Group

Catherine RebuldelaVice-President Middlefield Limited

Gabriel SolerVice-President Middlefield Group

Lidia AssaloneAssistant Vice-President Horizon on Bay Limited

Sylvia CasillanoAssistant Vice-President Middlefield Group

Tess DavidAssistant Vice-President Middlefield Group

Rose EspinozaAssistant Vice-President Middlefield Group

Elenita GarbinoVice-President Middlefield Group

Edmun TsangAssociate, Corporate Development Middlefield Capital Corporation

AuditorDeloitte LLP Chartered Accountants

Legal CounselBennett Jones Davies Ward Phillips & Vineberg LLP Fasken Martineau DuMoulin LLP McCarthy Tétrault

BankersBank of Montreal Canadian Imperial Bank of Commerce Royal Bank of Canada

CustodianRBC Investor Services Trust

AffiliatesMFL Management Limited MF Properties Limited Middlefield Group Limited Middlefield International Limited Middlefield Limited Middlefield Realty Services Limited Middlefield Capital Corporation Middlefield Ventures Limited

www.middlefield.com | [email protected] | (888) 890-1868

TORONTO, CANADAMiddlefield Capital Corporation First Canadian Place 58th Floor, P.O. Box 192 Toronto, Ontario Canada M5X 1A6

Telephone (416) 362-0714 Fax (416) 362-7925

CALGARY, CANADAMiddlefield Limited 812 Memorial Drive NW Calgary, Alberta Canada T2N 3C8

Telephone (403) 269-2100 Fax (403) 269-2911

LONDON, ENGLANDMiddlefield International Limited 288 Bishopsgate London, England EC2M 4QP

Telephone (0207) 814-6644 Fax (0207) 814-6611

SAN FRANCISCO, USAMiddlefield Financial Services Inc. One Embarcadero Center, Suite 500 San Francisco, California USA 94111

Telephone (415) 835-1308 Fax (415) 835-1350

debenture fundmiddlefield.com/pdf/path/report2012.pdf · initial public offering 1ryepber 2012...

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