Annual Report 2012 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

Transcription

1 Annual Report 2012 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

2 MIDDLEFIELD Performance. One Step at a Time. (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 Initial Public Offering March 2012 Initial Public Offering ril 2012 BMO CAPITAL MARKETS CANACCORD GENUITY CORP. $61,200,000 MIDDLEFIELD INCOME PLUS II CORP. anage b Mi le el r u CIBC WORLD MARKETS INC. Price: $12 per equity share NATIONAL BANK FINANCIAL INC. GMP SECURITIES L.P. SCOTIABANK INC. RBC CAPITAL MARKETS MACQUARIE PRIVATE WEALTH INC. TD SECURITIES INC. RAYMOND JAMES LTD. MIDDLEFIELD CAPITAL CORPORATION DUNDEE SECURITIES LTD. MACKIE RESEARCH CAPITAL CORPORATION $60,000,000 MRF 2012 RESOURCE LIMITED PARTNERSHIP anage b Mi le el r u CIBC WORLD MARKETS INC. BMO CAPITAL MARKETS Price: $25 per unit NATIONAL BANK FINANCIAL INC. SCOTIABANK RBC CAPITAL MARKETS TD SECURITIES INC. MACQUARIE PRIVATE WEALTH INC. MANULIFE SECURITIES INCORPORATED CANACCORD GENUITY CORP. GMP SECURITIES L.P. DUNDEE SECURITIES LTD. MIDDLEFIELD CAPITAL CORPORATION RAYMOND JAMES LTD. 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: invest@middlefield.com

3 Since its inception in 1979, the, 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. Treasury Offering August 2012 Treasury Offering Oct ber 2012 $43,031,700 PATHFINDER CONVERTIBLE DEBENTURE FUND anage by Mi le el r u Price: $12.33 per unit CIBC WORLD MARKETS INC. RBC CAPITAL MARKETS BMO CAPITAL MARKETS NATIONAL BANK FINANCIAL INC. SCOTIABANK INC. TD SECURITIES INC. CANACCORD GENUITY CORP. GMP SECURITIES L.P. MIDDLEFIELD CAPITAL CORPORATION RAYMOND JAMES LTD. MACQUARIE PRIVATE WEALTH INC. DUNDEE SECURITIES LTD. MIDDLEFIELD Canadian Income PCC $40,000,000 MIDDLEFIELD CANADIAN INCOME PCC anage by Mi le el Internati nal i ite TRADES ON THE LONDON STOCK EXCHANGE UNDER THE SYMBOL MCT CANACCORD GENUITY LIMITED Initial Public Offering e ber 2012 Initial Public Offering e ber 2012 $75,000,000 MIDDLEFIELD CAN-GLOBAL REIT INCOME FUND anage b Mi le el r u Price: $10 per unit $50,000,000 DISCOVERY 2012 FLOW-THROUGH LIMITED PARTNERSHIP anage b Mi le el r u Price: $25 per unit CIBC WORLD MARKETS INC. BMO CAPITAL MARKETS CANACCORD GENUITY CORP. NATIONAL BANK FINANCIAL INC. GMP SECURITIES L.P. SCOTIABANK RBC CAPITAL MARKETS MACQUARIE PRIVATE WEALTH INC. TD SECURITIES INC. RAYMOND JAMES LTD. RBC CAPITAL MARKETS CIBC WORLD MARKETS INC. SCOTIABANK BMO CAPITAL MARKETS NATIONAL BANK FINANCIAL INC. TD SECURITIES INC. MANULIFE SECURITIES INCORPORATED GMP SECURITIES L.P. MACQUARIE PRIVATE WEALTH INC. MIDDLEFIELD CAPITAL CORPORATION DUNDEE SECURITIES LTD. MACKIE RESEARCH CAPITAL CORPORATION CANACCORD GENUITY CORP. MIDDLEFIELD CAPITAL CORPORATION DUNDEE SECURITIES LTD. RAYMOND JAMES LTD. #1 NEUTRAL BALANCED MUTUAL FUND OVER 3-YEARS Middlefield Income Plus Class #1 NEUTRAL BALANCED MUTUAL FUND OVER 10-YEARS Middlefield Income Plus Class #1 NATURAL RESOURCE EQUITY FUND OVER 1-YEAR Groppe Tactical Energy Class

4 Middlefield CORPORATE PROFILE Since its inception in 1979, the, 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 Middlefield Mutual Funds Review and Outlook 6 Annual Management Report of Fund Performance 12 Management s Responsibility for Financial Reporting 12 Independent Auditor s Report 14 Financial Statements 18 Notes to Financial Statements 24 Middlefield Funds Family Corporate Information A NOTE ON FORWARD LOOKING STATEMENTS This 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.

5 MIDDLEFIELD MUTUAL FUNDS A multi-class family of mutual funds that allows investors to switch between classes tax-free ACTIVEINDEX REIT CLASS [MID 600/649/650] Series F [MID 601] The objective of this Fund is to outperform the S&P/TSX Capped REIT Index, through a combination of indexing and active portfolio management and entails investing primarily in securities of issuers in the Canadian real estate sector. GROPPE TACTICAL ENERGY CLASS [MID 125/127/130] Series F [MID 126] The objective of this Fund is to maximize long-term total return by investing in a portfolio comprised primarily of equity and fixed income securities of issuers that operate in or have exposure to the oil and gas industry. Groppe, Long and Littell, one of the world s leading forecasters of oil and gas prices, is special advisor in respect of this Fund. Groppe Tactical Energy Class received a Fundata FundGrade A Award in honour of outstanding performance for the period ending December 31, FUNDGRADE A AWARD MIDDLEFIELD CANADIAN DIVIDEND GROWTH CLASS [MID 148/449/450] Series F [MID 149] The objective of this Fund is to provide long-term growth of capital through investment in equity and some debt securities. Investments are primarily in the Canadian resource sector. MIDDLEFIELD GLOBAL AGRICULTURE CLASS [MID 161/163/166] Series F [MID 162] The objective of this Fund is to provide long-term growth of capital by investing in equity securities of issuers operating in the agricultural sector. MIDDLEFIELD CANADIAN HIGH YIELD CLASS [MID 300/349/350] Series F [MID 301] The objective of this Fund is to maximize long-term total return by investing primarily in equities, equityrelated securities and fixed income securities of Canadian issuers. MIDDLEFIELD INCOME PLUS CLASS [MID 800/849/850] Series F [MID 801] The objective of this Fund is to provide a stable level of income while emphasizing capital preservation by investing in a diversified portfolio of fixed income and equity securities. Income Plus Class received a 5-star rating from Morningstar and Fundata s FundGrade A Award for outstanding performance in the 2012 calendar year. 5-STAR RATING (MORNINGSTAR, FEBRUARY 25, 2013) FUNDGRADE A AWARD MIDDLEFIELD PRECIOUS METALS CLASS [MID 170/174/175] Series F [MID 171] The objective of this Fund is to provide long-term growth of capital by investing in equity and equityrelated securities of issuers that are engaged in the exploration and production of precious metals and minerals such as gold, silver, platinum, palladium, diamonds and other precious metals, minerals and gems, supplemented by the securities of issuers operating in the base metals and resource sectors. MIDDLEFIELD SHORT-TERM INCOME CLASS [MID 400/424/425] The objective of this Fund is to provide a high level of interest income by investing in high quality fixed income securities, while emphasizing capital preservation and liquidity. MIDDLEFIELD URANIUM FOCUSED METALS CLASS [MID 210/219/220] The objective of this Fund is to provide long-term growth of capital by investing in equity and equityrelated securities that are engaged in the exploration and production of metals and minerals including uranium, molybdenum, nickel, copper, lead, gold, diamonds, zinc and other base and precious metals and minerals, supplemented by the securities of resource service companies. All funds are fully RRSP and TFSA eligible. The Fund codes are listed in brackets beside each fund name. MIDDLEFIELD 2012 ANNUAL REPORT 3

6 MIDDLEFIELD MUTUAL FUNDS THE MIDDLEFIELD FAMILY OF MUTUAL FUNDS, WHICH IS LISTED AT THE END OF THIS REPORT, CURRENTLY COMPRISES NINE DIFFERENT CLASSES OF FUNDS. THE MULTI-CLASS STRUCTURE OF MIDDLEFIELD MUTUAL FUNDS LIMITED ENABLES INVESTORS TO SWITCH BETWEEN CLASSES BASED UPON THEIR INVESTMENT NEEDS WITHOUT TRIGGERING INCOME TAX CONSEQUENCES. IN ADDITION, ALMOST ALL CLASSES ARE OFFERED IN F SERIES AND ALL FEATURE A LOW-LOAD OPTION Review and Outlook In 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 structural reforms to facilitate deleveraging in developed economies and socio-economic improvements that will increase domestic demand. Despite the broader market volatility, several of our funds generated strong performance last year. The Income Plus Class Series A, which has consistently achieved a top quartile ranking during the past decade, delivered a total return of 4.5% in 2012 and an annualized compound return of 9.8% since inception in September The Income Plus Class ranked 2nd out of all funds in Canada in the Global Canadian Balanced category for the 10 years ended December 31, Both the ActiveIndex REIT Class Series A and Canadian High Yield Class Series A, which appreciated by 18.8% and 4.7% respectively on a total return basis in 2012, benefited from the low interest rate environment in North America, which we expect to prevail for the foreseeable future. Notably, our Global Agricultural Class Series A appreciated by 14.1% in 2012, despite challenging drought conditions in the U.S. 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 longterm 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 4 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

7 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. 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 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 the 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. The Canadian commercial real estate sector will continue to be supported by limited supply growth and a widespread improvement in rents and occupancy. REITs 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. The relative strength of the Canadian economy and low unemployment should continue to support domestic and international demand for commercial real estate. We believe that strong fundamentals, continued access to lowcost capital and cash flow growth will support additional dividend increases in 2013 from the REIT sector. Our 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 demonstrated 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 equity income securities, with a bias towards high quality companies with low debt and stable levels of dividends. Moreover, we continue to believe that Canada s wellcapitalized banking system, stable economy and abundance of natural resources continues to provide investors with very attractive investment opportunities. Dean Orrico President and Chief Investment Officer MIDDLEFIELD 2012 ANNUAL REPORT 5

8 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE FOR 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. Shareholders may contact us by calling , by writing to us at at one of the addresses on the back cover or by visiting our website at 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 STRATEGIES Middlefield Canadian High Yield Class (formerly, Middlefield Income and Growth Class) (the Fund ) is a mutual fund class of Middlefield Mutual Funds Limited (the Corporation ). The Fund is authorized to issue series of shares designated as Series A and F. Each series has a different management fee rate. The Fund first issued Series F shares on June 17, The Fund s objective is to maximize long-term total return. The Fund invests primarily in equities, equity-related securities and fixed-income securities of Canadian issuers. The Fund is not limited to how much it invests or keeps invested in each asset class. The mix can vary according to market conditions and expected returns for each asset class. 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 June 14, During 2012, the overall risk level of the Fund may have been impacted as follows: Interest Rate Risk The general level of interest rates impacts the earnings of the Fund. Rising interest rates serve to increase the earnings of the Fund while the reverse is true with declining interest rates. During 2012, the general levels of interest rates were low as economic stimulus remained the focus for many Central Banks globally. The Fund seeks to mitigate interest rate risk through active management and portfolio diversification. RESULTS OF OPERATIONS Investment Performance While there have been no fundamental changes to the investment objectives of the Fund, the investment portfolio was rebalanced in favour of debt securities in mid The net assets of the Fund decreased from $7.8 million at December 31, 2011 to $6.9 million at December 31, Net assets on a per share basis for Series A increased from $17.24 at December 31, 2011 to $18.02 at December 31, 2012 and for Series F increased from $17.34 to $ The increase in net assets on a per share basis was due to the performance of the investment portfolio, which was rebalanced in favour of debt securities during the year. A net gain on investments of approximately $128,300 was recorded in Revenue and Expenses Revenue for the year ended December 31, 2012 increased from approximately $325,000 in 2011 to $381,000 in 2012 primarily due to increased interest earnings from debt securities. Expenses for the year decreased slightly to approximately $176,000 from $184,000 in the prior year due to reduced net assets under management in The management expense ratio ( MER ) in 2012 was 2.45% for Series A and 1.40% for Series F, comparable to the MERs in 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. 6 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

9 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE FOR THE YEAR ENDED DECEMBER 31, 2012 The demand for Canadian high yield debt and convertible bonds remained strong in 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. Canadian high yield credit spreads are approximately 600 bps greater than 5-year Canadian Government bond yields of approximately 1.35%. 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, Middlefield Limited (the Manager ) receives a management fee. For further details please see the Management Fees section of this report. Middlefield Capital Corporation ( 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 FEES Management fees are calculated at 2.0% per annum for the Series A shares and 1.0% per annum for the Series F shares, of the Net Asset Value of each Series and are split between the Manager, the Advisor and investment dealers who receive trailing commissions. 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 On June 14, 2012, the Fund filed articles of amendment to change its name from Middlefield Income and Growth Class to Middlefield Canadian High Yield Class to better reflect its investment objectives. Future Accounting Changes International 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, 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, 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 share. 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 shares would be classified as a liability under IAS 32 Financial Instruments Presentation. Reclassification of the Fund s shares is not expected to have a material impact on the net asset value per share 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. MIDDLEFIELD 2012 ANNUAL REPORT 7

10 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE FOR THE YEAR ENDED DECEMBER 31, 2012 FINANCIAL HIGHLIGHTS The 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 Investment Fund Continuous Disclosure ( NI ) 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 Ratios and supplemental data are derived from the Fund s Net Asset Value. THE FUND S NET ASSETS PER SHARE (1) SERIES A Net Assets, Beginning of Year $ $ $ $ $ INCREASE (DECREASE) FROM OPERATIONS: Total Revenue Total Expenses (0.44) (0.44) (0.44) (0.38) (0.43) Total Income Tax Recoveries 0.04 Realized Gains (Losses) for the Year (0.23) (0.66) (0.67) Unrealized Gains (Losses) for the Year (1.09) (1.40) (3.55) Transaction Costs on Purchase and Sale of Investments (0.03) (0.04) (0.03) (0.02) (0.03) TOTAL INCREASE (DECREASE) FROM OPERATIONS (2) 0.78 (0.16) (3.75) Net Assets, End of Year $ $ $ $ $ THE FUND S NET ASSETS PER SHARE (1) SERIES F (4) Net Assets, Beginning of Year $ $ INCREASE (DECREASE) FROM OPERATIONS: Total Revenue Total Expenses (0.25) (0.12) Realized Gains for the Year Unrealized Losses for the Year (1.17) (1.54) Transaction Costs on Purchase and Sale of Investments (0.02) (0.01) TOTAL INCREASE FROM OPERATIONS (2) Net Assets, End of Year $ $ (1) This information is derived from the Fund s audited annual financial statements. The Net Assets per share presented in the financial statements differs from the Net Asset Value calculated for fund pricing purposes. An explanation of the difference can be found in the notes to the financial statements. (2) Net Assets are based on the actual number of shares outstanding at the relevant time. The increase (decrease) from operations is based on the weighted average number of shares outstanding over the financial period. (3) There were no dividends paid by the Fund. (4) For the period June 17, 2011 (date of commencement of operations) to December 31, MIDDLEFIELD CANADIAN HIGH YIELD CLASS

11 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE FOR THE YEAR ENDED DECEMBER 31, 2012 RATIOS AND SUPPLEMENTAL DATA SERIES A Total Assets (000s) (1) $ 6,387 $ 7,166 $ 7,076 $ 7,659 $ 7,419 Total Net Asset Value (000s) (1) $ 6,367 $ 7,143 $ 7,050 $ 7,638 $ 7,377 Number of Shares Outstanding (1) 351, , , , ,598 Management Expense Ratio ( MER ) (2) 2.45% 2.53% 2.74% 2.67% 2.67% Trading Expense Ratio (3) 0.20% 0.22% 0.17% 0.13% 0.19% Portfolio Turnover Rate (4) % 70.98% 42.74% 71.95% % Net Asset Value per Share $ $ $ $ $ RATIOS AND SUPPLEMENTAL DATA SERIES F (5) Total Assets (000s) (1) $ 567 $ 709 Total Net Asset Value (000s) (1) $ 565 $ 707 Number of Shares Outstanding (1) 30,733 40,675 Management Expense Ratio ( MER ) (2) 1.40% 1.37% Trading Expense Ratio (3) 0.20% 0.22% Portfolio Turnover Rate (4) % 70.98% Net Asset Value per Share $ $ (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. (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 June 17, 2011 (date of commencement of operations) to December 31, MIDDLEFIELD 2012 ANNUAL REPORT 9

12 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE FOR THE YEAR ENDED DECEMBER 31, 2012 PAST PERFORMANCE The performance information shown, which is based on Net Asset Value, assumes that all dividends 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 RETURNS The bar charts show how the Fund s performance has varied from year-to-year for each of the years shown. The return for Series F for 2011 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 the financial year would have grown or decreased by the last day of the financial year. ANNUAL TOTAL RETURNS % SERIES A ANNUAL TOTAL RETURN % SERIES F ANNUAL COMPOUND RETURNS Periods Ended December 31, 2012 One Year Three Years Five Years Ten Years Middlefield Canadian High Yield Class Series A 4.68% 4.57% 1.48% 6.43% S&P/TSX Composite Index 7.17% 4.78% 0.79% 9.20% Periods Ended December 31, 2012 Since One Year Inception Middlefield Canadian High Yield Class Series F 5.81% 5.09% S&P/TSX Composite Index 7.17% 1.14% The S&P/TSX Composite Index (the Index ) is comprised of Canadian stocks traded on the Toronto Stock Exchange (the TSX ) and is designed to represent the Canadian equity market. The Fund underperformed the Index in 2012 returning 4.68% compared to the Index return of 7.17%. In early 2012, the Fund s investment portfolio consisted mostly of Canadian stocks traded on the TSX. However, in mid 2012, the Fund s investment portfolio was rebalanced in favour of debt securities and underperformed the Index as a result of the change in portfolio composition from equities to debt securities. 10 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

13 ANNUAL MANAGEMENT REPORT OF FUND PERFORMANCE FOR THE YEAR ENDED DECEMBER 31, 2012 Summary of Investment Portfolio AS AT DECEMBER 31, 2012 TOP TWENTY-FIVE HOLDINGS DESCRIPTION % OF NET ASSET VALUE 1 Baytex Energy Corp % due July 19, Vermilion Energy Inc. 6.50% due February 10, HudBay Minerals Inc. 9.50% due October 01, Ag Growth International Inc. 7.00% due December 31, Great Canadian Gaming Corp % due July 25, Paramount Resources Ltd. 8.25% due December 13, Western Energy Services Corp % due January 30, Sherritt International Corp. 7.50% due September 24, InnVest Real Estate Investment Trust 5.85% due August 01, IAMGOLD Corp. 6.75% due October 01, Perpetual Energy Inc. 8.75% due March 15, Lake Shore Gold Corp. 6.25% due September 20, Postmedia Network Inc. 8.25% due August 16, MEG Energy Corp % due January 30, Trilogy Energy Corp. 7.25% due December 13, Southern Pacific Resource Corp. 6.00% due June 30, TransGlobe Energy Corp. 6.00% due March 31, PetroBakken Energy Ltd % due February 01, Athabasca Oil Corp. 7.50% due November 19, Encana Corporation 5.80% due January 18, Inmet Mining Corp. 8.75% due June 01, Superior Plus Corp. 8.25% due October 27, Gateway Casinos & Entertainment Ltd % due November 15, Precision Drilling Corp. 6.50% due March 15, Russel Metals Inc. 6.00% due April 19, Top Twenty-Five Holdings excludes any temporary cash investments. ASSET CLASS % OF NET ASSET VALUE Corporate Debt 97.0 Cash and Short-Term Investments 1.6 Other Assets (Liabilities) TOTAL NET ASSET VALUE $ 6,932,252 TOTAL ASSETS $ 6,953,992 The Summary of Investment Portfolio may change over time due to ongoing portfolio transactions. Please visit for the most recent quarter-end Summary of Investment Portfolio. MIDDLEFIELD 2012 ANNUAL REPORT 11

14 MANAGEMENT S RESPONSIBILITY FOR FINANCIAL REPORTING The financial statements of Middlefield Canadian High Yield Class (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. The Board carries out this responsibility through the Audit Committee. 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 shareholders their opinion on the financial statements. The auditor has full and unrestricted access to the Audit Committee. Robert F. Lauzon President Middlefield Limited March 13, 2013 Francisco Z. Ramirez Senior Vice-President and Chief Financial Officer Middlefield Limited INDEPENDENT AUDITOR S REPORT TO THE SHAREHOLDERS OF MIDDLEFIELD CANADIAN HIGH YIELD CLASS (formerly, Middlefield Income and Growth Class) We have audited the accompanying financial statements of Middlefield Canadian High Yield Class 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 net realized gain from investment transactions for the years then ended, and a summary of significant accounting policies and other explanatory information. MANAGEMENT S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS Management 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 RESPONSIBILITY Our 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. OPINION In our opinion, the financial statements present fairly, in all material respects, the financial position of Middlefield Canadian High Yield Class as at December 31, 2012 and 2011, and the results of its operations, changes in its net assets and net realized gain from investment transactions 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, MIDDLEFIELD CANADIAN HIGH YIELD CLASS

15 FINANCIAL STATEMENTS Financial Statements MIDDLEFIELD 2012 ANNUAL REPORT 13

16 FINANCIAL STATEMENTS STATEMENTS OF NET ASSETS AS AT DECEMBER ASSETS: Investments at Fair Value $ 6,689,861 $ 7,006,272 Cash 115, ,497 Income and Interest Receivable 116,854 70,096 Accounts Receivable 150,000 6,921,819 7,854,865 LIABILITIES: Management Fee Payable (Note 8) 15,281 17,074 Accounts Payable and Accrued Liabilities 6,459 7,805 21,740 24,879 Net Assets $ 6,900,079 $ 7,829,986 Net Assets Series A $ 6,337,235 $ 7,124,594 Net Assets Series F $ 562,844 $ 705,392 Mutual Fund Shares Issued and Outstanding Series A (Note 5) 351, ,141 Mutual Fund Shares Issued and Outstanding Series F (Note 5) 30,733 40,675 Net Assets per Share Series A (Note 7) $ $ Net Assets per Share Series F (Note 7) $ $ The accompanying notes to financial statements are an integral part of these financial statements. Approved by the Board of Directors: Director: Robert F. Lauzon Director: Francisco Z. Ramirez 14 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

17 FINANCIAL STATEMENTS STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER INVESTMENT INCOME: Interest $ 301,090 $ 140,094 Income from Investments 79, ,624 Securities Lending Income (Note 10) 1, , ,782 EXPENSES (Note 8): Management Fee 158, ,060 Securityholder Reporting Costs 6,884 5,191 Audit Fees 2,809 4,674 Filing Fees 2,675 7,390 Legal Fees 2,069 3,159 Fund Administration 1,985 1,021 Custodial Fees Network Fees 935 Directors Fees 1,000 Capital Tax (1,200) 175, ,149 Net Investment Income 205, ,633 NET GAIN (LOSS) ON INVESTMENTS AND TRANSACTION COSTS: Net Realized Gain from Investment Transactions 605, ,529 Change in Net Unrealized Loss on Investments (457,301) (632,476) Net Realized Loss from Foreign Currency Transactions (5,029) (43) Transaction Costs on Purchase and Sale of Investments (Note 9) (14,524) (17,218) Net Gain (Loss) on Investments and Transaction Costs 128,342 (196,208) Net Increase (Decrease) in Net Assets from Operations 333,713 $ (55,575) Net Increase (Decrease) in Net Assets from Operations Series A $ 300,414 $ (44,918) Net Increase (Decrease) in Net Assets from Operations Series F $ 33,299 $ (10,657) Net Increase (Decrease) in Net Assets from Operations per Share Series A (Note 5) $ 0.78 $ (0.11) Net Increase (Decrease) in Net Assets from Operations per Share Series F (Note 5) $ 0.98 $ (0.30) STATEMENTS OF NET REALIZED GAIN FROM INVESTMENT TRANSACTIONS FOR THE YEARS ENDED DECEMBER Proceeds from Sale of Investments $ 7,914,023 $ 4,975,432 Less: Cost of Investments Sold: Owned at Beginning of Year 6,525,051 5,644,874 Purchased During Year 7,449,722 5,402,080 Owned at End of Year (6,665,946) (6,525,051) 7,308,827 4,521,903 Net Realized Gain from Investment Transactions $ 605,196 $ 453,529 The accompanying notes to financial statements are an integral part of these financial statements. MIDDLEFIELD 2012 ANNUAL REPORT 15

18 FINANCIAL STATEMENTS STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2012 Series A Series F Total Net Assets at Beginning of Year $ 7,124,594 $ 705,392 $ 7,829,986 OPERATIONS: Net Increase in Net Assets from Operations 300,414 33, ,713 CAPITAL SHARE TRANSACTIONS: Proceeds from Issue of Shares 500,784 42, ,028 Payment on Redemption of Shares (1,588,557) (218,091) (1,806,648) (1,087,773) (175,847) (1,263,620) Net Decrease in Net Assets (787,359) (142,548) (929,907) Net Assets at End of Year $ 6,337,235 $ 562,844 $ 6,900,079 Total Assets $ 6,357,575 $ 564,244 $ 6,921,819 STATEMENTS OF CHANGES IN NET ASSETS FOR THE YEAR ENDED DECEMBER 31, 2011 Series A Series F Total Net Assets at Beginning of Year $ 7,038,002 $ $ 7,038,002 OPERATIONS: Net Decrease in Net Assets from Operations (44,918) (10,657) (55,575) CAPITAL SHARE TRANSACTIONS: Proceeds from Issue of Shares 2,030, ,049 2,746,927 Payment on Redemption of Shares (1,899,368) (1,899,368) 131, , ,559 Net Increase in Net Assets 86, , ,984 Net Assets at End of Year $ 7,124,594 $ 705,392 $ 7,829,986 Total Assets $ 7,147,984 $ 706,881 $ 7,854,865 The accompanying notes to financial statements are an integral part of these financial statements. 16 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

19 FINANCIAL STATEMENTS STATEMENT OF INVESTMENT PORTFOLIO AS AT DECEMBER 31, 2012 Description Par Value Average Cost Fair Value Ag Growth International Inc. 7.00% due December 31, ,000 $ 250,000 $ 259,375 Allied Nevada Gold Corp. 8.75% due June 01, ,000 99, ,250 Arcan Resources Ltd., 6.25% due February 28, , , ,500 Athabasca Oil Corp. 7.50% due November 19, , , ,375 Baytex Energy Corp % due July 19, , , ,666 Encana Corporation 5.80% due January 18, , , ,294 Epsilon Energy Ltd. 7.75% due March 31, , , ,500 Equal Energy Ltd. 6.75% due March 31, , , ,200 Fortress Paper Ltd. 7.00% due December 31, , , ,700 Gateway Casinos & Entertainment Ltd % due November 15, , , ,750 Great Canadian Gaming Corp % due July 25, , , ,297 HudBay Minerals Inc. 9.50% due October 01, , , ,238 IAMGOLD Corp. 6.75% due October 01, , , ,702 Inmet Mining Corp. 8.75% due June 01, , , ,895 InnVest Real Estate Investment Trust 5.85% due August 01, , , ,000 Lake Shore Gold Corp. 6.25% due September 20, , , ,000 MEG Energy Corp % due January 30, , , ,097 Paramount Resources Ltd. 8.25% due December 13, , , ,845 Perpetual Energy Inc. 8.75% due March 15, , , ,250 PetroBakken Energy Ltd % due February 01, , , ,023 Postmedia Network Inc. 8.25% due August 16, , , ,135 Precision Drilling Corp. 6.50% due March 15, , , ,688 Russel Metals Inc. 6.00% due April 19, , , ,174 Savanna Energy Services Corp. 7.00% due May 25, , , ,083 Sherritt International Corp. 7.50% due September 24, , , ,144 Southern Pacific Resource Corp. 6.00% due June 30, , , ,200 Superior Plus Corp. 8.25% due October 27, , , ,030 TransGlobe Energy Corp. 6.00% due March 31, , , ,000 Trilogy Energy Corp. 7.25% due December 13, , , ,938 Uranium One Inc. 5.00% due March 13, , , ,625 Vermilion Energy Inc. 6.50% due February 10, , , ,762 Western Energy Services Corp % due January 30, , , ,125 CORPORATE DEBT: 98.3% 6,667,802 6,689,861 EMBEDDED BROKER COMMISSIONS (Note 9) (1,856) TOTAL INVESTMENTS: 98.3% 6,665,946 6,689,861 CASH: 1.7% 115, ,104 Total Investment Portfolio, including Cash $ 6,781,050 $ 6,804,965 The accompanying notes to financial statements are an integral part of this financial statement. MIDDLEFIELD 2012 ANNUAL REPORT 17

20 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND MIDDLEFIELD CANADIAN HIGH YIELD CLASS Middlefield Canadian High Yield Class (formerly, Middlefield Income and Growth Class) (the Fund ) is one of 12 classes of mutual fund shares of Middlefield Mutual Funds Limited (the Corporation ), a mutual fund corporation continued under the laws of Alberta. Investors may diversify their holdings by switching between classes on a taxdeferred basis. The Fund is authorized to issue series of shares designated as Series A and F. Each series has a different management fee rate. The Fund first issued Series A shares on July 3, 2001 and Series F shares on June 17, The investment objective of the Fund is to maximize long-term total return by investing primarily in equities, equity-related securities and fixed-income securities of Canadian issuers. Middlefield Limited is the manager of the Fund (the Manager ). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. FUTURE ACCOUNTING CHANGES 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, 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, B. CREDIT RISK AND FAIR VALUE OF FINANCIAL INSTRUMENTS The 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. VALUATION OF SERIES Net assets are calculated for each series of shares of the Fund. The net assets of a particular series of shares is computed by calculating the value of the series proportionate share of the assets and liabilities of the Fund common to all series. Management fees directly attributable to a series are charged to that series. Other expenses, investment income and realized and unrealized gains and losses on investments are allocated proportionately to each series based upon the relative net assets of each series. D. 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. E. INVESTMENT TRANSACTIONS AND INCOME RECOGNITION Investment 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 an unrealized gain (loss) on investments. Income from investments is recognized on the exdividend or ex-distribution date. Interest income is recognized on an accrual basis. F. NET INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS PER SHARE Net increase (decrease) in net assets from operations per share in the Statements of Operations represents the increase (decrease) in net assets from operations for each series divided by the average shares outstanding for each series during the year. G. INCOME TAXES The Corporation qualifies as a mutual fund corporation as defined in the Income Tax Act (Canada) (the Tax Act ). The Corporation is subject to tax at the full corporate rate on its taxable income. Dividends received from taxable Canadian corporations are generally not included in the taxable income of the Corporation but are subject to a special tax, refunded at a rate of 33 1/3% of taxable dividends distributed by the Corporation to its shareholders. Capital gains realized in the year are included in the taxable income of the Fund at the applicable capital gains rate. The Corporation is eligible for a refund calculated on a formula basis when mutual fund shares are redeemed or when capital gains dividends are paid to shareholders. The Corporation endeavours to pay out sufficient Canadian dividends and net capital gains so that it will not be subject to refundable income taxes in respect of income from those sources. However, the Corporation will be liable for non-refundable income tax if its income from other sources exceeds its expenses for the year. 18 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

21 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. INCOME TAXES (CONTINUED) Temporary differences between the carrying values of assets and liabilities for accounting and income tax purposes give rise to future income tax assets and liabilities. The most significant temporary difference is that between the reported fair value of the investment portfolio and its adjusted cost base ( ACB ) for income tax purposes. To the extent that the fair value of the portfolio exceeds its ACB, a future tax liability arises. Since capital gains taxes payable by the Corporation are refundable under the relevant provisions of the Tax Act, the future tax liability is fully offset by these future refundable taxes. Conversely, when the ACB exceeds the fair value of the portfolio, a future tax asset is generated. In such cases, a full valuation allowance is taken to offset this asset given the uncertainty that such future tax assets will ultimately be realized. H. RETURN OF CAPITAL Distributions 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. I. FOREIGN CURRENCY TRANSLATION Foreign currency amounts are translated into Canadian dollars as follows: fair value of investments, forward currency contracts and other assets and liabilities, at the closing rate of exchange on each business day; income and expenses, and purchases, sales and settlements of investments, at the rate of exchange prevailing on the respective dates of such transactions. J. FINANCIAL INSTRUMENTS The carrying values of financial instruments, including cash, receivables, payables and accruals approximate the fair value due to their short maturities. K. USE OF ESTIMATES The 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 accrued liabilities. Actual results could differ from those estimates. L. SECURITIES LENDING The Fund may enter into securities lending transactions. These transactions involve the temporary exchange of securities as collateral with a commitment to deliver the same securities on a future date. Income is earned from these transactions in the form of fees paid by the counterparty and, in certain circumstances, interest paid on securities held as collateral. Income earned from these transactions is recognized on an accrual basis and is included in the Statements of Operations. 3. FAIR VALUE DISCLOSURE The 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 Level 2 Level 3 Inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date. 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. 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. MIDDLEFIELD 2012 ANNUAL REPORT 19

22 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND FAIR VALUE DISCLOSURE (CONTINUED) As at December 31, 2012 Description Level 1 Level 2 Level 3 Total Cash $ 115,104 $ $ $ 115,104 Debt Securities 1,932,100 4,757,761 6,689,861 Total $ 2,047,204 $ 4,757,761 $ $ 6,804,965 As at December 31, 2011 Description Level 1 Level 2 Level 3 Total Cash $ 628,497 $ $ $ 628,497 Common Shares 4,378,850 4,378,850 Trust Units 668, ,650 Debt Securities 861,645 1,097,127 1,958,772 Total $ 6,537,642 $ 1,097,127 $ $ 7,634,769 No transfers between levels have occurred during the years ended December 31, 2012 and FINANCIAL RISK MANAGEMENT In the normal course of business the Fund is exposed to a variety of financial risks: price risk, interest rate risk, liquidity risk and credit risk. The Fund s primary risk management objective is to protect earnings and cash flow and, ultimately, shareholder 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. PRICE RISK Price 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: Investments at Fair Value $ $ 5,047,500 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 $nil (2011 $504,750) increase or decrease in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant. 20 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

23 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND FINANCIAL RISK MANAGEMENT (CONTINUED) B. 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 financial assets such as debentures and notes 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 Less than 1 Year 1 to 5 Years Greater than 5 Years Total Debt Securities $ $ 3,112,297 $ 3,577,564 $ 6,689,861 Cash 115, ,104 Total Exposure $ 115,104 $ 3,112,297 $ 3,577,564 $ 6,804,965 As at December 31, 2011 Less than 1 Year 1 to 5 Years Greater than 5 Years Total Debt Securities $ 175,172 $ 976,661 $ 806,939 $ 1,958,772 Cash 628, ,497 Total Exposure $ 803,669 $ 976,661 $ 806,939 $ 2,587,269 Based on the above exposure at December 31, 2012 a 1% per annum increase or decrease in interest rates would result in a $284,500 (2011 $57,833) decrease or increase in net assets of the Fund as at December 31, 2012 and 2011, with all other factors held constant. C. LIQUIDITY RISK Liquidity 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 daily cash redemptions of its shares. The shares of the Fund are issued and redeemed on demand at the net asset value per share. All other obligations of the Fund 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 and cash equivalent positions to maintain liquidity and comply with liquidity requirements as outlined by securities legislation and its investment policies. D. 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 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. MIDDLEFIELD 2012 ANNUAL REPORT 21

24 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND FINANCIAL RISK MANAGEMENT (CONTINUED) D. CREDIT RISK (CONTINUED) As at December 31, 2012 and 2011 the Fund was invested in debt instruments with the following credit ratings: As a % of Net Assets Debt Instruments by Credit Rating* B 17.5 BB B CCC+ 6.4 BB 5.7 BB+ 3.8 BBH 3.7 BBB Ba1 2.6 B- 3.0 No Rating * Credit ratings from Standard & Poor s and Moody s. 5. SHARE CAPITAL The mutual fund shares and five common shares of the Corporation have equal rights and privileges except that the common shares may not be redeemed. Changes in mutual fund shares of the Fund are summarized as follows: Number of Shares Series A Shares Outstanding at Beginning of Year 413, ,435 Shares Issued 28, ,750 Shares Redeemed (89,520) (108,044) Net Increase (Decrease) (61,414) 8,706 Shares Outstanding at End of Year 351, ,141 Number of Shares Series F Shares Outstanding at Beginning of Year 40,675 Shares Issued 2,363 40,675 Shares Redeemed (12,305) Net Increase (Decrease) (9,942) 40,675 Shares Outstanding at End of Year 30,733 40,675 The average number of Series A shares outstanding during 2012 was 384,552 ( ,097) and the average number of Series F shares outstanding during 2012 was 33,880 ( ,047). These numbers were used to calculate the respective net increase (decrease) in net assets from operations per share. 6. CAPITAL MANAGEMENT The Fund s capital is its net assets, representing shareholders 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 shareholders, maximize shareholder value and maintain financial strength. The Fund is not subject to any externally imposed capital requirements. The Fund s overall strategy with respect to capital risk management remains unchanged from the year ended December 31, MIDDLEFIELD CANADIAN HIGH YIELD CLASS

25 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2012 AND NET ASSETS AND NET ASSET VALUE National Instrument 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 Series A share as at December 31, 2012 was $18.10 (2011 $17.29) compared to the Net Assets per Series A share of $18.02 (2011 $17.24). The Net Asset Value per Series F share as at December 31, 2012 was $18.40 ( ) compared to the Net Assets per Series F share of $18.31 ( ).). 8. MANAGEMENT FEE AND OPERATING EXPENSES The Manager provides investment and administrative services to the Fund. In consideration for such services the Manager receives a monthly fee in arrears based on each series of shares as a percentage of the average daily Net Asset Value of the series. The management fee for Series A is 2% per annum and for Series F is 1% per annum. Common expenses incurred by the Fund are allocated among the series on a pro-rata basis among all shares of all series. The Manager is reimbursed for reasonable costs related to maintaining the Fund and preparation and distribution of financial statements and other documents to shareholders. The Fund is responsible for the payment of all expenses relating to the operation of the Fund and the carrying on of its business. The management expense ratios for 2012 for Series A of 2.45% ( %) and for Series F of 1.40% ( ) are the ratios of expenses for each series to average Net Asset Value of each series and are based on annualized expenses for the year. 9. TRANSACTION COSTS Brokerage commissions and other transaction costs paid in connection with securities transactions during 2012 amounted to $14,524 (2011 $17,218). Included in this amount is $8,655 (2011 $10,280) in brokerage commissions that were paid to Middlefield Capital Corporation, a company under common control with the Manager. 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. 10. SECURITIES LENDING The Fund has entered into a securities lending program with its custodian. The Fund receives collateral of at least 105% of the value of the securities on loan. Collateral is generally comprised of cash and obligations of, or guaranteed by, the Government of Canada or a province thereof, or the United States Government or its agencies. Collateral may also be comprised of securities that are convertible into, or exchangeable for, securities of the same issuer as the securities that are on loan. The market values of the securities on loan and the related collateral at December 31, 2012 were both $nil (2011 $1,277,000 and $1,341,000, respectively). 11. LOSS CARRYFORWARDS At December 31, 2012 and 2011 the Corporation did not have any capital losses or non-capital losses available for carryforward for tax purposes. 12. COMPARATIVE AMOUNTS Management Fee Payable and Accounts Payable and Accrued Liabilities in 2011 have been reclassified to conform with the current year presentation. REDEMPTION OF SECURITIES Shares of a Middlefield Mutual Fund may be redeemed at the net asset value thereof next determined after receipt at the registered office of the Fund of a redemption request. Requests received after 4:00 pm on any business day will be deemed to be received by the Fund on the next business day following the day of actual receipt thereof. Application for redemption may be forwarded directly to the Fund by shareholders or to dealers or brokers for delivery to the Fund. An application for redemption must be signed by the shareholder with the signature guaranteed by a Canadian chartered bank or trust company or by a member of a recognized stock exchange in Canada or any other guarantor acceptable to the Fund. If the shareholder is a corporation, partnership, agent, fiduciary or surviving joint owner, additional documentation may be required. MIDDLEFIELD 2012 ANNUAL REPORT 23

26 Middlefield FUNDS FAMILY TSX-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 Series A Shares Fund Code 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 24 MIDDLEFIELD CANADIAN HIGH YIELD CLASS

27 CORPORATE INFORMATION Directors Murray J. Brasseur Chairman Dennis da Silva Managing Director Resource Group Middlefield Capital Corporation Richard L. Faiella, CFA Managing Director Corporate Development Middlefield International Limited W. Garth Jestley, CFA Deputy Chairman Middlefield International Limited Robert F. Lauzon, CFA Managing Director Western Canada Middlefield Capital Corporation Dean Orrico President and Chief Executive Officer Middlefield Capital Corporation Sylvia V. Stinson Executive Vice-President and Chief Financial Officer Independent Review Committee George S. Dembroski Former Vice-Chairman RBC Dominion Securities Limited H. Roger Garland Former Vice-Chairman Four Seasons Hotels Inc. Bernard I. Ghert (Chairman) Former Chairman Mount Sinai Hospital Charles B. Young Former Deputy Chairman Canary Wharf Advisors Groppe, Long & Littell Guardian Capital LP Middlefield Capital Corporation Officers Henry Lee President Middlefield Realty Services Limited Nick Lombardi President MF Properties Limited Jeremy T. Brasseur Managing Director Corporate Development Middlefield Capital Corporation Nancy Tham Managing Director Sales and Marketing Middlefield Capital Corporation Andy Nasr Executive Director, Corporate Development and Portfolio Management Middlefield Capital Corporation Michael Bury Director, Sales and Marketing Middlefield Capital Corporation Douglas D. Sedore Director Horizon on Bay Limited Michael T. Kimeda Senior Vice-President and Chief Financial Officer Middlefield Capital Corporation J. Dennis Dunlop Senior Vice-President Maria F. Herrera Senior Vice-President Dinah Mason Senior Vice-President Horizon on Bay Limited Francis Ramirez Senior Vice-President and Chief Compliance Officer Middlefield Capital Corporation Polly Tse Senior Vice-President and Chief Financial Officer MFL Management Limited Nicole S. Brasseur Vice-President Stephen Chamberlain Vice-President Middlefield Realty Services Limited Stacy J. Crestohl Vice-President Shiranee Gomez Vice-President Vincenzo Greco Vice-President Middlefield Limited Terry Landriault Vice-President Judy Marks Vice-President Lilibeth Mondejar Vice-President Horizon on Bay Limited Victor Ngai Vice-President Catherine Rebuldela Vice-President Middlefield Limited Gabriel Soler Vice-President Lidia Assalone Assistant Vice-President Horizon on Bay Limited Sylvia Casillano Assistant Vice-President Tess David Assistant Vice-President Rose Espinoza Assistant Vice-President Elenita Garbino Vice-President Edmun Tsang Associate, Corporate Development Middlefield Capital Corporation Auditor Deloitte LLP Chartered Accountants Legal Counsel Bennett Jones Davies Ward Phillips & Vineberg LLP Fasken Martineau DuMoulin LLP McCarthy Tétrault Bankers Bank of Montreal Canadian Imperial Bank of Commerce Royal Bank of Canada Custodian RBC Investor Services Trust Affiliates MFL Management Limited MF Properties Limited Limited Middlefield International Limited Middlefield Limited Middlefield Realty Services Limited Middlefield Capital Corporation Middlefield Ventures Limited MIDDLEFIELD 2012 ANNUAL REPORT 25

28 TORONTO, CANADA Middlefield Capital Corporation First Canadian Place 58th Floor, P.O. Box 192 Toronto, Ontario Canada M5X 1A6 Telephone (416) Fax (416) CALGARY, CANADA Middlefield Limited 812 Memorial Drive NW Calgary, Alberta Canada T2N 3C8 Telephone (403) Fax (403) LONDON, ENGLAND Middlefield International Limited 288 Bishopsgate London, England EC2M 4QP Telephone (0207) Fax (0207) SAN FRANCISCO, USA Middlefield Financial Services Inc. One Embarcadero Center, Suite 500 San Francisco, California USA Telephone (415) Fax (415) (888)